Prop Regs Make Significant Changes to Rules on MACRS Property Dispositions
(Parker Tax Publishing: September 28, 2013)

In 2011, the IRS released temporary and proposed regulations, both with the same text, on the accounting for, and dispositions of, MACRS property. Last week, in REG-110732-13 (9/19/13), the IRS withdrew those proposed regulations but left the temporary regulations in place. In place of the proposed regulations, the IRS issued new proposed regulations that provide significant changes to the rules for determining asset dispositions and qualifying dispositions of an asset in a general asset account.

The newly released proposed regulations are proposed to apply to tax years beginning on or after January 1, 2014. The regulations also permit taxpayers to rely on the provisions of the proposed regulations for tax years beginning on or after January 1, 2012, and before the applicability date of the final regulations. The proposed regulations provide that taxpayers may apply the provisions of the final regulations to tax years beginning on or after January 1, 2012. The temporary regulations allow taxpayers to apply the temporary regulations to tax years beginning on or after January 1, 2012, but the final regulations will provide that taxpayers may not apply the temporary regulations to tax years beginning on or after January 1, 2014.

Determining Assets Disposed of and Partial Dispositions

Temporary Regulations

The temporary regulations under Reg. Sec. 1.168(i)-8T provide rules for determining gain or loss upon the disposition of MACRS property that are generally consistent with the disposition rules for accelerated cost recovery system (ACRS) property (which have been generally applied to MACRS property). However, if an abandoned asset is subject to nonrecourse debt, the temporary regulations clarify that the asset is treated in the same manner as an asset disposed of by sale.

The temporary regulations under Sec. 1.168(i)-1T provide rules for establishing general asset accounts, for computing depreciation for general asset accounts, and for determining gain or loss upon the disposition of assets in general asset accounts. The temporary regulations provide that, in general, no loss is recognized upon the disposition of an asset from a general asset account. However, a taxpayer may elect to recognize gain or loss upon the disposition of an asset in a general asset account if there is a qualifying disposition. The temporary regulations define the term disposition to include the retirement of a structural component of a building and define the term qualifying disposition to allow the recognition of gain or loss upon most dispositions of assets in general asset accounts. Thus, a taxpayer has the option of recognizing a loss on most dispositions of assets in general asset accounts under the temporary regulations.

The temporary regulations also provide rules for determining the disposed asset. They provide that the facts and circumstances of each disposition are considered in determining the appropriate disposed asset. In general, the asset for disposition purposes cannot be larger than the unit of property as determined under Reg. Sec. 1.263(a)-3(e)(2), (e)(3), and (e)(5) or other applicable guidance. However, each building is the asset for disposition purposes, unless more than one building is treated as the asset under Reg. Sec. 1.1250-1(a)(2)(ii). If the building includes two or more condominium or cooperative units, then each condominium or cooperative unit (instead of the building) is the asset for disposition purposes. Consistent with including a retirement of a structural component of a building as a disposition, the temporary regulations provide that each structural component of a building, condominium unit, or cooperative unit is the asset for disposition purposes. Further, if a taxpayer properly includes an item in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87-56 or classifies an item in one of the categories under Code Sec. 168(e)(3) (other than a category that includes buildings or structural components; for example, retail motor fuels outlet and qualified leasehold improvement property), each item is the asset provided it is not larger than the unit of property as determined under Reg. Sec. 1.263(a)-3(e)(3) or (e)(5). Consistent with Code Sec. 168(i)(6), the temporary regulations also provide that if the taxpayer places in service an improvement or addition to an asset after the taxpayer placed the asset in service, the improvement or addition is a separate asset for depreciation purposes. The temporary regulations also provide that a taxpayer generally may use any reasonable, consistent method to treat each of an asset's components as the asset for disposition purposes.

Proposed Regulations

These proposed regulations change the rule in the temporary regulations that each structural component of a building, condominium, or cooperative is the asset for tax disposition purposes. The proposed regulations provide that a building (including its structural components), a condominium (including its structural components), or a cooperative (including its structural components) is the asset for disposition purposes. This rule allows taxpayers to forgo a loss upon the disposition of a structural component of a building without making a general asset account election.

Example 1: ABC Company owns an office building with four elevators. ABC replaces one of the elevators. The elevator is a structural component of the office building. The office building (including its structural components) is the asset for disposition purposes. ABC does not make the partial disposition election (discussed below) for the elevator. Thus, the retirement of the replaced elevator is not a disposition. As a result, depreciation continues for the cost of the building (including the cost of the retired elevator and the building's other structural components), and ABC does not recognize a loss for this retired elevator. If ABC must capitalize the amount paid for the replacement elevator, the replacement elevator is a separate asset for disposition purposes and for depreciation purposes.

Example 2: The facts are the same as in Example 1, except ABC accounts for each structural component of the office building as a separate asset in its fixed asset system. Although ABC treats each structural component as a separate asset in its records, the office building (including its structural components) is the asset for disposition purposes. Accordingly, the result is the same as in Example 1.

The proposed regulations also provide that the disposition rules apply to a partial disposition of an asset (for example, the disposition of a roof (or a portion of the roof)). This rule allows taxpayers to claim a loss upon the disposition of a structural component (or a portion thereof) of a building or upon the disposition of a component (or a portion thereof) of any other asset without identifying the component as an asset before the disposition event. The partial disposition rule also minimizes circumstances in which an original part and any subsequent replacements of the same part are required to be capitalized and depreciated simultaneously. The proposed regulations provide examples demonstrating the application of the partial disposition rule.

In many cases, the partial disposition rule is elective. However, the partial disposition rule is required to be applied to a disposition of a portion of an asset as a result of a casualty event, to a disposition of a portion of an asset for which gain is not recognized in whole or in part under the like-kind exchange provisions of Code Sec. 1031 or the involuntary conversion provisions of Code Sec. 1033, to a transfer of a portion of an asset in a step-in-the-shoes transaction described in Code Sec. 168(i)(7)(B), or to a sale of a portion of an asset. Consequently, a disposition includes a disposition of a portion of an asset under these circumstances, even if the taxpayer does not make the partial disposition election for that disposed portion. For other transactions, a disposition includes a disposition of a portion of an asset only if the taxpayer makes the partial disposition election for that disposed portion.

A taxpayer may make the partial disposition election for the disposition of a portion of any type of MACRS property. However, a taxpayer making the partial disposition election for the disposition of a portion of an asset that is properly included in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87-56 must classify the replacement portion of the asset under the same asset class as the disposed portion of the asset.

Compliance Tip: The partial disposition election is made on the taxpayer's timely filed original federal tax return, including extensions, for the tax year in which the portion of the asset is disposed of by the taxpayer. This election may not be made or revoked by the filing of an application for a change in method of accounting. A taxpayer may revoke a partial disposition election by filing a request for a letter ruling and obtaining IRS consent to revoke the election. The IRS may grant a request to revoke this election if the taxpayer acted reasonably and in good faith, and the revocation will not prejudice the interests of the IRS.

In addition, the proposed regulations provide a special partial disposition rule to address practitioners' concerns about the effect of an IRS disallowance of a taxpayer's characterization of the replacement of a portion of an asset as a repair. When the IRS disallows a taxpayer's repair deduction for the amount paid or incurred for the replacement of a portion of an asset and capitalizes such amount under Reg. Sec. 1.263(a)-2 or Reg. Sec. 1.263(a)-3, the taxpayer may make the partial disposition election for the disposition of the portion of the asset to which the IRS's adjustment pertains by filing an application for change in accounting method, provided the asset of which the disposed portion was a part is owned by the taxpayer at the beginning of the year of change.

The proposed regulations also provide that the disposition rules apply to a partial disposition of an asset included in a general asset account. Consequently, a disposition includes a disposition of a portion of an asset as a result of a casualty event, a disposition of a portion of an asset for which gain is not recognized in whole or in part under Code Sec. 1031 or Code Sec. 1033, a transfer of a portion of an asset in a transaction described in Code Sec. 168(i)(7)(B), a sale of a portion of an asset, or a disposition of a portion of an asset in a transaction described under the anti-abuse rules applicable to general asset accounts. For other transactions, a disposition includes a disposition of a portion of an asset only if the taxpayer makes the election to terminate the general asset account upon the disposition of all assets, including that disposed portion, in that general asset account or makes the qualifying disposition election for that disposed portion. A separate partial disposition election is not provided for assets in a general asset account because a taxpayer can claim a loss upon the disposition of an asset (or a portion thereof) in a general asset account only when the taxpayer makes these two elections.

Because the partial disposition rule under the proposed regulations allows taxpayers to treat the disposition of an asset's component as a disposition, the IRS believes that the rule in the temporary regulations allowing taxpayers to use any reasonable, consistent method to treat an asset's components as the asset for disposition purposes is no longer needed. Accordingly, the proposed regulations do not include that temporary regulations rule.

OBSERVATION: The IRS is requesting comments on whether the rule in the temporary regulations allowing taxpayers to use any reasonable, consistent method to treat an asset's components as the asset for disposition purposes is still needed.

The proposed regulations modify the temporary regulations' definition of a disposition to provide that a disposition includes the disposition of a structural component (or a portion thereof) of a building only if the partial disposition rule applies to such structural component (or a portion thereof).

Finally, the proposed regulations change the definition of a qualifying disposition. Under the proposed regulations, a qualifying disposition is a disposition that does not involve all the assets, the last asset, or the remaining portion of the last asset, remaining in a general asset account and that is:

- a direct result of a fire, storm, shipwreck, or other casualty, or from theft;

- a charitable contribution for which a deduction is allowable;

- a direct result of a cessation, termination, or disposition of a business, manufacturing, or other income-producing process, operation, facility, plant, or other unit (other than by transfer to a supplies, scrap, or similar account); or

- generally a transaction to which a nonrecognition section of the Code applies.

Determination of Basis and Identification of Disposed or Converted Asset

Temporary Regulations

The temporary regulations provide that if the disposed asset is in a general asset account, is in a multiple asset account, or is a component of a larger asset, and it is impracticable from the taxpayer's records to determine the unadjusted depreciable basis of the disposed asset, the taxpayer may use any reasonable method that is consistently applied to the taxpayer's general asset accounts, multiple asset accounts, or larger assets, as applicable, to make such a determination.

Proposed Regulations

The proposed regulations provide nonexclusive examples of reasonable methods. Such examples include:

(1) discounting the cost of the replacement asset to its placed-in-service year cost using the Consumer Price Index;

(2) a pro rata allocation of the unadjusted depreciable basis of the general asset account or multiple asset account, as applicable, based on the replacement cost of the disposed asset and the replacement cost of all of the assets in the general asset account or multiple asset account, as applicable; and

(3) a study allocating the cost of the asset to its individual components.

As previously noted, these proposed regulations do not include the temporary regulation rule that allows taxpayers to use any reasonable, consistent method to treat an asset's components as the asset for tax disposition purposes. Consistent with that change, the proposed regulations do not include the temporary regulation rules regarding the determination of the unadjusted depreciable basis, and identification, of the disposed component of a larger asset. However, the proposed regulations provide rules regarding the determination of the unadjusted depreciable basis, and identification, of the disposed portion of an asset when the partial disposition rule applies.

If the partial disposition rule applies, the proposed regulations provide that a taxpayer may use any reasonable method for determining the unadjusted depreciable basis of the disposed portion of the asset. Also, if a taxpayer disposes of more than one portion of the same asset, the taxpayer may use any reasonable method that is 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 proposed regulations provide nonexclusive examples of reasonable methods.

If a taxpayer disposes of a portion of the asset and the partial disposition rule applies to that disposition, the proposed regulations provide rules regarding the identification of the asset. When it is impracticable from the taxpayer's records to determine the particular tax year in which the asset was placed in service by the taxpayer, the taxpayer must identify the asset by using the methods allowed when the asset is in a general asset account or a multiple asset account: the first-in, first-out (FIFO) method, the modified FIFO method, a mortality dispersion table if the asset is a mass asset, or any other method designated by the IRS in published guidance. A last-in, first-out (LIFO) method is not permitted.

Other Changes

The proposed regulations provide that if a taxpayer disposes of a portion of an asset and the partial disposition rule applies to that disposition, the taxpayer must account for the disposed portion in a single asset account beginning in the tax year in which the disposition occurs.

Parker Tax Publishing Staff Writers

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