Proposed Regulations on Dispositions Under the Modified Accelerated Cost Recovery System

Although the IRS released final regulations that refine and simplify the rules for determining whether an expense may be deducted as a repair or must be capitalized, the Service chose not to finalize the regulations governing general asset accounts (GAAs) and the disposition of depreciable property under the Modified Accelerated Cost Recovery System (MACRS). Instead, proposed regulations were issued that make significant changes within this highly-controversial area.

Background

Before the temporary regulations were issued in 2011, if you retired a structural component of a building, you could not treat the retirement as a disposition and take a loss. In such cases, you continued to depreciate the retired component (for example, a retired roof) and began depreciating the replacement component (a new roof).

Under the 2011 temporary regulations, a retirement of a structural component was treated as a disposition of an asset and a loss was claimed equal to the remaining adjusted basis of the retired structural component. Unfortunately, in some instances this rule had an adverse impact because amounts paid for the replacement of a component of property that otherwise were deductible as repair costs were required to be capitalized. To alleviate this result, the rules were revised for MACRS general asset accounts (GAAs).

Under the revised rules, if you placed a building or other asset in a GAA, you were not required to claim a loss upon its retirement unless an affirmative election was made to treat the retirement as a “qualifying disposition.” Although the election for qualifying dispositions was previously available in only a few select circumstances, the temporary regulations extended this treatment to virtually any disposition if an asset was placed in a GAA.  Therefore, the decision on whether or not to treat the retirement of an asset (such as a structural component) as a “qualifying disposition” was based on whether or not the replacement costs constituted deductible repair expenses.

Partial Disposition Election

The proposed regulations that were issued on September 13, 2013 create a “partial disposition” election for assets that are not in GAAs. If the election is made, you may recognize a loss on the retirement of a structural component; if the election is not made, you continue to depreciate the basis of the retired component. This election allows you to treat the retirement of any portion of an asset as a disposition.

For example, you can make the election to treat the retirement of an entire roof as a partial disposition or any portion of the roof, such as the shingles, as a partial disposition, if you want to recognize a loss. For assets other than buildings, the partial disposition election may also be made upon the disposition of a component of the asset, or a portion of a component of an asset. There are certain specified dispositions where it is mandatory to recognize gain or loss; for example, the disposition of an asset as a result of a casualty.

An additional rule protects you if you decide not to treat a retirement as a partial disposition in order to claim a repair deduction, but under audit are told the repair deduction should have been capitalized. In such cases, you can file an accounting method change to make the partial disposition election and claim the loss on the replaced component.

Modified General Asset Account (GAA) Rules

The proposed regulations modify the GAA rules to redefine a qualifying disposition for which an election may be made to recognize a gain or loss by limiting the election to the few select types of dispositions that were treated as qualifying dispositions prior to the temporary regulations.

However, the recognition of gain or loss upon the partial disposition of a portion of an asset is required for specified dispositions that are not in a GAA. For other transactions, a disposition includes a disposition of a portion of an asset in a GAA only if the election is made to terminate the GAA upon the disposition of all assets, including the disposed portion, in that GAA.

Effective date.The IRS plans to finalize the proposed regulations quickly so they can have the same January 1, 2014 effective date as the final regulations that control the expense vs. capitalize rules. If this deadline is not met, the IRS may apply the regulations retroactively to January 1, 2014. In any case, you may rely on the proposed regulations for tax years beginning on or after January 1, 2012.

Because the proposed regulations affect virtually every business, a thorough review of your fixed assets, any projected dispositions, and your current accounting policies are warranted. We would be happy to answer any questions you have, and help you to implement these rules for your business.  Please contact our office at your earliest convenience.