Final regulations on dispositions of tangible property may affect basis recovery

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The IRS has released final regulations (TD 9689) on dispositions and partial dispositions of tangible depreciable property. The final regulations also amend the general asset account regulations. Taxpayers will want to determine how the new rules in the regulations may affect their current methods of grouping assets and recovering basis after dispositions.

These regulations finalize the reproposed regulations that were published with the final tangible property “repair regulations” released in September 2013 (TD 9636) regarding when costs incurred to acquire, produce or improve tangible property must be capitalized or may be deducted. (For a discussion of the reproposed disposition regulations and the final tangible property regulations, see Tax Flash 2013-13.)

The final regulations on dispositions apply to taxable years beginning on or after Jan. 1, 2014, but may be adopted early for years beginning on or after Jan. 1, 2012.  Similarly, a taxpayer may choose to rely on the reproposed regulations for taxable years beginning on or after Jan. 1, 2012, and beginning before Jan. 1, 2014.

General rules for dispositions
The final regulations on dispositions apply to tangible property subject to modified accelerated cost recovery system (MACRS) depreciation under Section 168. Generally, they adopt the reproposed regulations with few changes and clarifications. The regulations provide:

  • A definition of “disposition” that includes the sale, exchange, retirement, physical abandonment or destruction of an asset
  • Rules for determining what asset has been disposed of, including specifically providing that improvements and additions are separate assets from the property improved
  • An election for taxpayers to apply the disposition rules to a partial disposition of an asset (for example, the disposition of a roof or a portion of a roof)
  • Mandatory treatment of certain partial dispositions such as casualty losses
  • A special partial disposition rule to address the effect of the IRS disallowance of a repair deduction in a later year
  • A method for determining the year an asset was placed in service and the basis of the asset was disposed of, particularly if the asset is in a multiple asset account or is a partial disposition, and it is impractical to specifically identify the asset
  • Rules for whether and to what extent gain or loss is recognized are subject to other applicable provisions, including Section 280B
  • Rules for establishing general asset accounts (GAA) and treatment of dispositions of assets included in a GAA
One of the more significant changes from the reproposed regulations is the determination of the basis of disposed assets. The final regulations remove the example that provided that taxpayers could discount the cost of the replacement asset by the Consumer Price Index to determine the basis of the disposed asset. Instead, the final regulations say that taxpayers may discount the cost of the replacement asset using the Producer Price Index for Finished Goods (and its successor, the Producer Price Index for Final Demand) only if the replacement asset is a restoration under Treas. Reg. Sc. 1.263(a)-3(k) and is not a betterment under Treas. Reg. Sec. 1.263(a)-3(j) or an adaption to a new or different use under Treas. Reg. Sec. 1.263(a)-3(l).

The final regulations also add examples for:

  • Reasonable methods for determining the amount of basis disposed in a partial disposition (or a multiple asset account)
  • A pro rata allocation of the unadjusted depreciable basis of the asset based on the replacement cost of the disposed portion of the asset and the replacement cost of the asset
  • A study allocating the cost of the asset to its individual components
The reasonable method used by the taxpayer for partial dispositions must be consistently applied to all portions of the same asset for purposes of determining the unadjusted depreciable basis of each disposed portion of the asset.

The IRS is expected to issue a new revenue procedure that will provide the procedures for implementing the final disposition regulations, and that the procedures will be similar to those provided in Rev. Proc. 2014-17. For a discussion of Rev. Proc. 2014-17, see Tax Flash 2014-03.   

Limited time to make late partial disposition election
One of the most significant opportunities under the final disposition regulations is the ability to recover basis upon the partial disposition of property, such as when a component of a building is disposed of during a renovation. The regulations provide that the loss upon disposition is allowed if an election is made on a timely filed return for the year of disposition.  

Rev. Proc. 2014-17 contains an important exception to this rule and allows a late partial disposition election (including a Section 481(a) catch-up adjustment) to be made for dispositions in prior taxable years, but only for federal income tax returns for taxable years beginning before Jan. 1, 2014. The IRS has stated publicly that they are considering whether to provide one more year for taxpayers to
make the late partial dispositions election (that is, for the first taxable year beginning on or after Jan. 1, 2014), but that the retroactive election will not be available for any later years. Therefore, taxpayers have a limited period of time to take advantage of this potential significant cash flow opportunity.  

Next steps

As mentioned before, taxpayers should determine how the new rules may affect their methods of grouping assets and recovering basis after dispositions. As soon as the IRS releases the related revenue procedures, taxpayers should also determine the timing for making automatic method changes to comply with the new rules. Taxpayers will also have a limited period to take advantage of the method changes for making late partial disposition elections and revoking late general asset account elections.

Sharon Kay

Ellen Fitzpatrick

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