20A — December 6 - 19, 2013 — Mid Atlantic Real Estate Journal
www.marejournal.com
F inancial D igest
By Arthur DaPonte, David Mendelsohn and Daniel Asbaty, WithumSmith & Brown, PC The long-awaited final repair and maintenance regulations: they’re here…
enumerated building systems is required to be done sepa- rately. Building systems are defined as structural compo- nents separate from the build- ing structure, such as HVAC, plumbing, electrical, escala- tors, elevators, fire protection, alarm, and security systems. Building structure is defined as the bricks and mortar and everything else not included in a specific building system. Each system project needs to be analyzed separately to de- termine proper accounting. For example, if you replace a roof membrane to fix a leak it may not be a major component, but replacing a chiller unit in the HVAC system to fix a cooling mechanism would be a major component. Amajor component or substantial structural part of a unit of property is an amount paid to restore (and therefore improve) a unit of property. The determination of whether a component or part is “major” or “substantial” depends on the facts and circumstances, including both qualitative and quantitative factors. A major component focuses on the function of the component within the unit of property. It is a part or combination of parts that performs a discrete and critical function in the operation of a unit of property. A substantial structural part focuses on the size of a replace- ment component in relation to a unit of property. It is a part or combination of parts that comprises a large portion of the physical structure of a unit of property. For example, a switch generally performs a discrete function (turning property on and off) and is critical to the operation of a unit of property Continued from page 14A Continued from page 15A relinquished property is sold, the QI will transfer the replace- ment property to complete the transaction. Strict compliance with these two timeframes (45 days/180 days) is critical to a success- ful exchange. Otherwise, the owner may lose the ability to defer the gain. If the property being ex- changed is subject to a mort- gage, the QI will pay off the mortgage at the time of the
(that is, machine will not run without it). This incidental component of a unit of property, even though such a component performs a discrete and criti- cal function in the operation of a unit of property, generally will not, by itself, constitute a major component and should be expensed. MATERIALS AND SUPPLIES In addition to further guid- ance on betterments, the new regulations also include direc- tion with regard to materi- als and supplies. The final regulations have expanded the definition of materials and supplies to include items with an acquisition cost of $200 or less and removed the restric- tion formerly placed on standby emergency spare parts. On a similar note, final regu- lations retain the rule allowing a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and sup- plies, but have amended the rule to only apply to rotable, temporary, or standby emer- gency spare parts. This election must be made on a timely filed tax return including exten- sions. Additionally, the regula- tions provide that a taxpayer who elects to use the optional method for rotable and tempo- rary spare parts for Federal income tax purposes must use the optional method for all of the pools of rotable and tem- porary spare parts used in the same trade or business regard- less of book treatment. DE MINIMIS SAFE HAR- BOR ELECTIONS The final regulations also provide guidance on electing the use of the de minimis safe harbor rules. This election al- sale of the property. In order to prevent the mortgage payoff from being considered deemed cash received (which results in a taxable gain) the seller must either take out a new mortgage on the replacement property greater than or equal to the mortgage being repaid, or contribute additional cash to the transaction to offset any reduction in the mortgage. From a tax perspective, the new property takes on the basis of the old property. By way of
lows taxpayers to obtain benefi- cial treatment for the amounts that qualify for these elections. The de minimis safe harbor regulations are applicable un- der the following sections: The regulations provide a de minimis exception permitting a taxpayer to deduct $5,000 (per invoice or per item) paid for tangible property if the taxpayer has an audited fi- nancial statement, has writ- ten accounting procedures (beginning January 1, 2014) for expensing amounts paid for such property and treat these amounts as expenses on the financial statement. The IRS is explicitly clear that in order to deduct $5,000 under the de minimis safe harbor regula- tions, the entity must undergo an audit. Reviews and compila- tions do not qualify. The regulation provides a de minimis safe harbor ceiling on amounts paid for property hav- ing an economic useful life of 12 months or less as long as the amount of the invoice or item does not exceed $5,000. Under either procedure, if the cost exceeds $5,000 per in- voice or item, then the amounts paid will not fall under the de minimis safe harbor. Also, an anti-abuse rule is provided to aggregate costs that are im- properly split among multiple invoices. A taxpayer without an au- dited financial statement may rely on the de minimis safe har- bor only if the amount paid for property does not exceed $500 per invoice or item. The regula- tion provides a de minimis safe harbor ceiling on amounts paid for property having an eco- nomic useful life of 12 months or less as long as the amount of example, assume a real estate investor is selling a property worth $5 million in which the taxpayer has a net basis of $1 million. The taxable gain would have been $4 million. Assum- ing the replacement property costs at least $5 million, and the exchange qualifies for non- recognition, the $4 million gain will not be currently taxed. The basis of the new property will take on the basis of the prop- erty sold, which is $1 million. The deferred $4 million gain
the invoice or item does not ex- ceed $500. Also, an anti-abuse rule is provided to aggregate costs that are improperly split among multiple invoices. The regulations provide that the de minimis rule as a safe harbor is elected annually by including a statement on the taxpayer’s timely filed original Federal income tax return for the year elected. If elected, the de minimis safe harbor must be applied to all amounts paid in the taxable year for tangible property and amounts paid for materials and supplies. The taxpayer may not revoke an election to use the de minimis safe harbor and the election may not be changed through the filing of an application for change in accounting method. The regulations require that the de minimis safe harbor be applied to all eligible materials and supplies (other than spare parts) if the taxpayer makes an election under 1.263(a)-1(f). The final repair and mainte- nance regulations do not su- persede prior revenue regula- tions regarding materials and supplies. For example, Rev. Proc 2002-12 (2002-1 CB 374) allows a taxpayer to treat small wares, which consist of items such as glassware, paper, and plastic cups, as materials and supplies that are not incidental to be deductible in the taxable year in which the materials are used or consumed in the taxpayer’s operations, such as in a restaurant. The regulations include a safe harbor election for building property held by taxpayers with gross receipts of $10,000,000 or less or a building unit that is owned and leased, provided the unadjusted basis is $1,000,000 will become taxable once the replacement property is sold years later (unless another exchange is entered into). While like-kind exchanges are popular with real estate investors, and may become even more so starting in 2013, they are not always the best strategy. A seller of real estate needs to consider additional factors: are there capital loss carryovers, is the property be- ing held at a gain or loss, the impact of the passive activity
or less. They permit a taxpayer to elect to not apply the im- provement rules to an eligible building property if the amount paid for repairs and mainte- nance do not exceed the lesser of $10,000 or 2% of the unad- justed basis of the building. This may be elected annually on a building-by-building basis by including a statement on the Federal income tax return. The regulations also provide for a safe harbor for routine maintenance for buildings. The IRS defines routine main- tenance on buildings as main- tenance that the taxpayer reasonably expects to perform more than once during a ten year period. A taxpayer’s ex- pectation will not be unreason- able just because the taxpayer does not actually perform the maintenance a second time. Routine maintenance for prop- erty other than buildings is the recurring activities that a taxpayer expects to perform in order to keep the unit of prop- erty in its ordinarily efficient operating condition. Examples include inspections, cleaning and testing of the property, and replacement of damaged or worn parts. These final regulations are intended to help you decide whether or not to capitalize the next major expense item you incur. Much like all areas of accounting, there is still some room for interpretation and case by case scenarios. Discuss this topic in depth with your tax practitioner now to ensure compliance with the new regu- lations by January 1, 2014. Contact the WS+B Real Estate ServiceGroupwithanyquestions. RebeccaMachingaCPA, Practice Leader, www.withum.com n rules and current tax rates. As with any significant transac- tion, you should consult with your tax advisor to determine if a like-kind exchange is the optimal strategy when selling your property. Sefi Silverstein, share- holder, has been withWilkin & Gullenplan since 1985. Sefi specializes in providing tax consulting, tax compli- ance and related accounting services to closely-held busi- nesses and individuals . n
Sefi Silverstein, Wilkin & Guttenplan . . .
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