Tangible Property Regulations: Why You May Not Want to Take Advantage of the Recent IRS Relief
February 25, 2015
In this second installment of our two-part blog post series on Tangible Property Regulations, Stephen Bishop, a Senior Manager with SC&H Group’s Tax Services team, explains why some taxpayers may not want to take advantage of the new Revenue Procedure recently announced by the IRS.
As mentioned in my last post, the IRS released Revenue Procedure 2015-20, which allows certain taxpayers the opportunity to adopt the new Tangible Asset Property Regulations, commonly known as “TARS”, without having to file a Form 3115. The Form 3115 is one of the Internal Revenue Service’s more complex forms, and if the taxpayer (or his or her tax preparer) is not familiar with the form or the task of completing the form – it could be overwhelming. It is because of this burden that the IRS released Revenue Procedure 2015-20.
This revenue procedure will allow the taxpayer to comply with the new regulations prospectively beginning January 1, 2014. Beginning on that date, the taxpayer begins to use the new regulations and considers only purchases, acquisitions, and dispositions occurring after that date.
For many, this new simple adoption method makes perfect sense and should be used. For others, particularly those who own real property or other assets that have a depreciable life greater than 7 years, the use of the simple method could leave major tax benefits untapped – and could set the taxpayer up for higher taxes when the property is eventually sold.
Some of the benefits of filing a Form 3115 – and not using the simple approach – are as follows:
The Ability To Write Off Previously Capitalized Assets: Without the use of the simplified method, TARS would require the taxpayer to go back and look at their old fixed assets and ask the question: “Would I have originally capitalized this asset if TARS had been in place at the time?” For real property owners, the answer to that question would be “no” in many instances. In that case, the taxpayer would file a Form 3115 with their 2014 tax return and take a current year tax deduction to write off the adjusted basis of the asset in question as of January 1, 2014. Because of the long term depreciable life of real property, the adjusted basis of those assets would provide significant deductions in 2014
The Ability To Avoid Depreciation Recapture: But you might say, “my building has been around for many years and those assets are almost or fully depreciated so there is not much benefit”. This would be true if you were just concerned with 2014’s results. The fact is that you are removing the asset as well as the accumulated depreciation. When the building is eventually sold and a gain is realized, the accumulated depreciation associated with the real property will be “recaptured” and a portion of the gain equal to the accumulated depreciation taken will be taxed at 25% and not the typical capital gain rate of 20%. So, the “scrubbing” of fixed assets and removal of eligible assets – and the associated accumulated depreciation – will create both a current year deduction and will help reduce future year taxes.
The Ability To Take Advantage of a Prior Partial Disposition: A fixed asset study or scrubbing might also identify a major component of a building that was replaced in prior years. For example, let’s say you bought a building in 1999 and in 2010 you replaced the roof and capitalized it under the old law. Let’s also assume that under TARS the new roof would be classified as a capital asset as well. Under TARS you are allowed to write off the adjusted basis of a building structural component i.e. the original roof when it is replaced. This was not allowed under the prior law. Furthermore, for 2014 only, a taxpayer is allowed to go back and write off a portion of an old asset that was replaced in a prior year. In our example, the portion of the 1999 building that represented the roof could be written off in 2014. The use of the Prior Partial Disposition Rule is not available under the simplified method or in future tax years.
The Ability To Benefit From Lenient Repair Rules: Under TARS expenditures that would not be capitalized as a betterment, new adaptation, or restoration would be considered a repair. In addition, TARS carves out certain expenditures, which are considered to be Safe Harbor Routine Maintenance expenditures. By filing a 3115 and not adopting the simple approach, the taxpayer can use these favorable rules in prior years.
The Ability To Have Audit Protection: By going through the fixed asset study and filing a 3115 the taxpayer enjoys audit protection. This could be an important benefit because it means that under most situations the IRS would not be able to look at your fixed assets and depreciation deductions from years before 2014 and force an adjustment in those years. If a 3115 is filed and the IRS disputes those older items, and is successful, they could only change the adjustment taken in 2014 as part of the 3115. The simple approach does not offer this audit protection.
The above are just a few of the major benefits of a Form 3115 that are not afforded under the simple approach. Taxpayers should tread carefully as they may unknowingly agree to forgo the above mentioned benefits. Consent to be bound by the simple approach described in Revenue Procedure 2015-20 is automatically given by merely failing to attach a Form 3115 to their 2014 tax return. There is a “use it or lose it” aspect to these regulations, if you do not identify these opportunities for prior year adjustments with your 2014 tax return, you cannot do so on a future tax return. Therefore, it is extremely important that taxpayers who own real property or lease real property discuss this new simple approach, including its benefits and traps, with their tax advisor prior to filing their 2014 tax return.
In most cases preparing and filing a Form 3115 offers the most benefits and protections to owners of real property. If you have any questions about TARS, Revenue Procedure 2015-20, Form 3115, or the benefits of a fixed asset study, we welcome you to contact Steve here.