Retroactive Adjustment for Late Partial Dispositions Election Permitted for 2014

On August 14, 2014, IRS issued long-awaited final regulations for dispositions of tangible property applicable to tax years beginning on or after January 1, 2014. The final regulations generally retain all the provisions of the proposed disposition regulations issued in 2013 with certain clarifications.

One of the most favorable aspects of the new regulations is the partial disposition election. A late partial disposition election can be treated as a change in method of accounting, with a retroactive Sec. 481(a) adjustment, but only for tax years beginning before January 1, 2015. The late partial disposition accounting method change allows taxpayers to reach back to prior tax years—even closed tax years—and take immediate deductions on disposed property still being depreciated. 

Background

Dispositions of depreciable property occur when an asset is sold, exchanged, retired, abandoned, or destroyed, effectively removing the asset from business use. If an asset has an adjusted basis of more than zero, the taxpayer is allowed to elect to treat the disposition as a loss for computing taxable income. This is a timely-filed election that generally must be made in the year of disposition by treating the disposition as a loss in the tax return. No separate election statement is required. Because the partial disposition election is an election and not a method of accounting, taxpayers were seemingly precluded from taking a loss on property physically disposed in prior years that the taxpayer continues to depreciate.

When a taxpayer determines that an expenditure is an improvement rather than a repair, the cost of the improvement must be capitalized. The partial disposition election allows the taxpayer to recover the tax basis in the property that is being replaced and disposed, even if it is only a portion of an asset. There is generally little difficulty in identifying the adjusted bases for certain assets, such as a computer or automobile. Often, however, the taxpayer will not have records to support the cost of a portion of an asset. Assets such as buildings, for example, comprised of many components and systems are commonly booked as a single asset, whether it be newly constructed or acquired. Years later, when a portion of that asset is repaired or otherwise disposed, the taxpayer not only depreciates the repair but also continues to depreciate the disposed asset. 

Application

For example, a taxpayer that replaced the roof on its 20 year old manufacturing facility for a cost of $1,000,000 and capitalized the cost of the replacement roof as an improvement under Sec. 263(a), is likely depreciating the cost of the new roof, as well as the old roof, for tax purposes. The partial disposition election allows the taxpayer to deduct the remaining tax basis in the old roof. The final regulations also provide that reasonable methods can be used to estimate the cost of the tax basis in the disposed asset, given that most taxpayers have not calculated or tracked the tax basis of a portion of an asset in many cases. Thus, the taxpayer does not need to have detailed historical records to make a reasonable allocation. For example, the regulation provides that back-trending a current replacement cost to the date the disposed asset was placed in service using producer price indices is a reasonable method. Accumulated depreciation then can be recalculated specific to the disposed asset to arrive at the adjusted basis that can be deducted as the current year loss. 

Taxpayers should analyze the benefit of making a late partial dispositions election at the same time that they are analyzing the impact of the tangible property regulations under Sec. 263(a). Both sets of rules provide many taxpayers with opportunities to significantly accelerate tax deductions. The late partial disposition election is made by filing Form 3115 for tax years beginning on or after January 1, 2012, and before January 1, 2015. For tax years beginning on or after January 1, 2015, taxpayers will only be allowed to make the partial disposition loss election for the tax year in which the disposition occurs (or in connection with certain IRS audit adjustments). This accounting method change presents a one-time opportunity to take a retroactive adjustment for disposed property in connection with the review of repair and maintenance activity required to implement the final regulations for repairs under Regs. 1.263(a)-3. A partial disposition election can also generate a negative AMT adjustment, providing some relief for taxpayers subject to AMT.

Andersen can help taxable companies increase their cash flows by taking advantage of this quickly expiring opportunity. If you have capitalized improvements related to depreciable property, let us help you determine deductible costs eligible for the late partial disposition election or deductible as repairs.