How the new repairs and
maintenance capitalization standards
will impact your next remodel
Restaurant Finance Conference
November 14, 2012
© 2012 Baker Tilly Virchow Krause, LLP
Baker Tilly refers to Baker Tilly Virchow Krause, LLP,
an independently owned and managed member of Baker Tilly International.
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Contact information
J h Hoffman
John
H ff
312 729 8003
[email protected]
2
Agenda
> Overview of the temporary regulations
–
–
–
–
Unit of property
Capitalization standards
De minimis rule and materials and supplies
Changes to depreciation and disposition rules
> Transition guidance and other issues
> Next steps
> Questions
3
Overview of the temporary regulations
4
Overview
What are the new repair regulations?
> Standards for determining whether and when costs incurred
in acquiring, maintaining, or improving tangible property must
be capitalized
p
> Framework for analysis of whether an expense is
– Currently deductible as an ordinary and necessary business
expense
OR
– Treated as a capital improvement and depreciated over a
l
longer
recovery period
i d
5
Overview
When are they effective?
> The temporary regulations have the same binding effect as
final regulations and are effective for tax years beginning on
or after Januaryy 1,, 2012
Who do they affect?
> Companies across nearly all industries with the largest
iimpactt on th
those h
having
i llarge iinvestments
t
t iin property,
t plants,
l t
and equipment
Especially restaurants
6
Unit of property
Unit of property = buildings
> Building structure
> Building systems
–
–
–
–
–
–
–
–
HVAC
Plumbing
Electrical
Escalators
Elevators
Fire protection
Security
Gas distribution
7
Unit of property examples
Real Property Expenditure
Unit of Property
Building Structure/System
R l
Replace
rooff
B ildi
Building
B ildi structure
Building
t t
Replace roof top HVAC unit
Building
HVAC system
Drive thru improvements
Building
Land Improvement
Building structure
Land Improvement
Restroom renovation
Building
Building structure (finishes)
Plumbing system (fixtures)
Dining area renovations
Building
Building structure
Façade update
Building
Building structure
Lighting
g
g upgrade
pg
Building
g
Electrical system
y
8
Improvement standards
An amount paid must be capitalized if it results in a
> Betterment to the unit of property
> Adaptation to a new or different use
> Restoration to the unit of property
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Improvement standards
Examples – restaurant building roof
1. General repairs – patching, caulking joints, etc.
2. Roof replaced with same materials, remaining cost of
original roof written off
3. Roof replaced with composite, energy-efficient materials
For #2 and #3, consider relativity – replacing components of
relative comparable quality and function
For example, the technology for a 20 year old roof top unit has
changed dramatically
10
Improvement standards
Common restaurant scenarios
1. General building or equipment repairs
2. Minor renovation or remodeling
3 Re-image/re-branding
3.
Re image/re branding
4. Remodel of dining room and/or kitchen
5. Addition and remodel
6. Acquisition & subsequent costs
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R&M flowchart
Replacement of a component
for which a loss on disposition
was property recognized?
Betterment – capitalize
Unit of property =
building
yes
Replacement of a component for
which gain/loss on sale properly
recognized?
Damage for which a casualty
loss has already been claimed?
or
Results in material
addition or
expansion?
Returned building structure or
system to former operating
condition after it was no longer
functioning?
or
or
Results in material
increase in quality,
capacity, productivity
or efficiency?
Capitalize
Adapts the unit of property
to new or different use?
Directly benefited or was incurred
by reason of an improvement to
the structure or system?
no
Supporting documentation and
scope of work supports deductible
repair treatment?
no
yes
Capitalize
Rebuilt the property to like new
condition after the class life?
or
Replacement of major
component or substantial
structural part?
no
yes
no
or
or
• HVAC
• Plumbing
• Electrical
• Escalators
• Elevators
• Fire protection
• Security
• Gas distribution
yes
or
Fixes a material
condition or defect
present at
acquisition or
production?
Affects the building
structure and/or one
or more building
systems:
Capitalize
no
Expense all costs
except tangible
personal property
yes
Restoration – capitalize
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Routine maintenance safe harbor
> Exception to capitalization
> Routine maintenance expected to be performed more
than once during the property’s class life (generally 9
years for restaurant equipment) due to the taxpayer’s
use of the property and to keep the property in its
ordinarily efficient operating condition
> Does not apply to
– Betterments
– Certain restorations
– Buildings
13
Routine maintenance safe harbor
Examples
> Condenser replacements for walk ins, control units,
motor systems
> Parking lots
The safe harbor does not apply to building maintenance
costs / repairs
14
De minimis rule
Costs to acquire or produce property do not have to be
capitalized
it li d if the
th taxpayer
t
> Has an “applicable financial statement” (AFS)
> Has a written accounting policy for expensing acquisition costs
>
less than a certain dollar amount
Expenses those costs on its AFS in accordance with its policy
Ceiling amount
> The aggregate amount deducted is less than or equal to the
greater of
– 0.1
0 1 percent of gross receipts for federal income tax purposes
– 2 percent of total book depreciation and amortization expense
15
Changes to depreciation and disposition rules
16
Changes to disposition rules
> Expand a disposition to include structural components of
>
>
>
>
buildings
b
ildi
Intended to reduce the unfavorable impact of the new
capitalization standards on buildings
Loss deduction is generally mandatory
May choose not to recognize loss with general asset
account election
Any reasonable allocation method
17
Changes to disposition rules
> Depreciation grouping rules
>
>
>
>
– Single asset account (SAA)
– Multiple asset account (MAA)
– General asset account (GAA)
Taxpayers must elect GAA treatment
GAA eligible assets
– Placed in service in the same tax year
– Same depreciation method, same recovery period, same
convention
GAA disposition rule – generally, no loss recognized
GAA beneficial for real property
18
Changes to disposition rules
> General MACRS disposition rules
>
>
– Includes retirement of structural components
– Loss recognition is mandatory
– Potentially significant administrative burden
Dispositions of property from a GAA
– “Qualifying disposition” includes retirement of structural
components
– Loss recognition is optional
– Easier to administer, but no current deduction for retired
components
GAA election is made on current year tax return (line 18
on Form 4562)) but accounting
g method change
g is
required for prior tax years
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General asset account election flowchart
Yes
Capitalize new roof membrane
Loss recognition on retirement/
disposal is optional
Did taxpayer recognize loss?
Yes
No
Deduct new membrane,
continue depreciating original
component
GAA election in place?
Yes
Capitalize new roof membrane
No
Loss recognition on retirement/
disposal is mandatory
Did ttaxpayer recognize
i lloss?
?
No
Capitalize new roof membrane,
stop depreciating original
component, remaining basis
“lost”
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Impact of disposition rules
Opportunity
Risk
• Deduct adjusted basis of disposed
structural component
• Section 481(a) adjustment
• How to determine adjusted basis in
structural components?
• If SAA/MAA used for building and its
components, depreciation must stop
and loss must be taken or lost
• Loss would preclude repair deduction
• Solution = GAA election
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Relevant issues related to disposition rules
> Cost segregation analysis before change to disposition
rules
l
– Focus only on segregating personal property and land
improvements
>
– Group all section 1250 real property into one 39-year
bucket
Cost segregation
g g
analysis
y after change
g to disposition
p
rules
– Proactively break out major building components on new
construction for future R&M and disposal purposes
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Transition guidance and other issues
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Transition rules
Modifications to the automatic consent procedures in
R
Rev.
P
Proc. 2011
2011-14
14
> Rev. Proc. 2012-19
– Method changes for costs to maintain or improve tangible
property
– Method changes for costs to acquire or produce tangible
property
• Transaction costs
• De minimis rule
• Materials and supplies
> Rev. Proc. 2012-20
– Rules for accounting for MACRS property including GAAs and
dispositions
24
Transition rules
Changes to comply with the regulations are generally
accounting
ti
method
th d changes
h
> Generally section 481(a) catch up adjustment
> Cut-off method for costs incurred after December 31,, 2011
– De minimis rule
– Transaction cost exceptions
– Materials and supplies
> Item-by-item elections going forward
– Capitalize and depreciate supplies
– Not
N t tto apply
l d
de minimis
i i i rule
l
– Capitalize otherwise deductible transaction costs
– GAA
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Filing procedures
> Taxpayers may combine certain related and similar
changes
h
iin R
Rev. P
Proc. 2012
2012-19
19 on a single
i l F
Form 3115
> Taxpayers may combine certain related and similar
changes in Rev. Proc. 2012-20 on a single Form 3115
> Positive and negative section 481(a) adjustments may be
accounted for separately
– 4-year
y
spread
p
of p
positive ((unfavorable)) adjustment
j
– No spread of negative (favorable) adjustment
> Duplicate filing requirement
– Original with timely filed tax return by extended due date
– Copy to Ogden, Utah (not Washington, DC)
• May be filed earlier for audit protection
> No user fees
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Late general asset account elections
Make a late GAA election
> Must be made for
f the taxpayers 1st
1 or 2nd
2 taxable year beginning
>
after December 31, 2011
Section 481(a) adjustment
Includes making a late election to recognize gain or loss in
a GAA
> Upon disposition of all the assets or the last asset
> Upon disposition of an item in a qualifying disposition
Example
> Taxpayer owns restaurant building which had its entire roof
>
>
replaced
Cost have been capitalized twice since being placed in service
What are the options?
27
Scope limitations
Section 4.02 of Rev. Proc. 2011-14 precludes taxpayers from
fili
filing
under
d the
th automatic
t
ti changes
h
procedures
d
if the
th taxpayer:
t
>
>
>
>
Is under exam
Has engaged in a section 381(a) transaction in the year of change
Is in its final year of trade or business
Has changed its method of accounting for the same item within the
past 5 years
Rev. Procs. 2012-19 and 2012-20 provide waiver of scope
limitations for 2 years (2012 and 2013)
> Do not need to be in a window period and may change
change, even if issue
>
under consideration or pending in exam, appeals, or court
Generally receive audit protection unless issue pending when Form
3115 is filed (i.e., notice of proposed adjustment)
28
LB&I directive
> Large Business and International (LB&I) Division directive on
examination
i ti activity
ti it iissued
d on M
March
h 15
15, 2012
2012, ffrom
Commissioner of the LB&I to industry directors, director-field
specialists, and director-international business compliance
> For tax years beginning before January 1, 2012
– All exam activity should cease
– No new activityy should commence
– Exam should withdraw all IDRs and NOPAs
> Does not apply to issues before appeals, court, or SBSE
division
– Likely that government will follow suit
29
Transition rules – other
> Statistical sampling permitted (Rev. Proc. 2011-42)
>
>
>
>
– Extrapolation not mentioned but may come out in future
f
guidance
Automatic consent conditioned on section 263A compliance
Scope limitations waived
Audit protection and LB&I directive
Concurrent Form 3115 filings allowed
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Next steps
31
Companies need to take action
> Compliance with the new regulations may require many
companies to change their current
c rrent methods of acco
accounting
nting for
R&M costs
> Regulations are generally unfavorable for companies that
h
have
already
l d fil
filed
d an accounting
ti method
th d change
h
d
due tto th
the
introduction of building systems (but can be mitigated by the
new disposition rules)
> Companies that have not filed an accounting method change for
R&M will likely benefit from the regulations if they are following
GAAP capitalization standards
> Changes to comply with the regulations are accounting method
changes made with a section 481(a) adjustment so analysis of
assets placed in service before 2012 can be reviewed now
32
Next steps
> Determine an effective way to comply with the new
regulations
l ti
– Companies who have already filed an accounting method
change, review prior years’ expenditures for conformity with
th new regulations
the
l ti
– Companies who have not filed an accounting method change,
review prior years’ expenditures to determine benefit from the
new regulations.
l ti
> Determine basis in retired structural components and
analyze the impact of the disposition rules on R&M
deductions
> FIN 48 considerations
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Impact
Companies need to analyze the impact of the new
regulations
l ti
if they:
th
> Have recently or are planning to remodel their restaurant(s)
> Alreadyy filed a method change
g under section 162 relying
y g on
prior law
> Have an ongoing R&M project
> Are involved in IRS controversy for this issue
> Have not yet filed a method change or have been waiting for
this final guidance
34
Timing
> Effective for tax years beginning on or after January 1, 2012
> Companies can begin reviewing their current method of
accounting and costs incurred prior to 2012 since the
accounting method change requires a section 481(a)
adjustment
> LB&I stand down order on reviewing capital versus
improvement
p
treatment
> FIN 48 considerations for 2012
35
Questions?
Questions
36
Contact information
John Hoffman
312 729 8003
[email protected]
@
y
37
Disclosure
The content in this presentation is a resource for Baker Tilly Virchow Krause, LLP
clients and prospective clients. Nothing contained in this presentation shall be
construed as legal advice, opinion, or as an offer to buy or sell any property or
services. In conformity with U.S. Treasury Department Circular 230, tax advice
contained in this communication and any attachments is not intended to be used,
and cannot be used, for the purpose of avoiding penalties that may be imposed
under the Internal Revenue Code, nor may any such tax advice be used to
promote, market or recommend to any person any transaction or matter that is the
subject of this communication and any attachments. The intended recipients of this
communication and any attachments are not subject to any limitation on the
disclosure of the tax treatment or tax structure of any transaction or matter that is
the subject of this communication and any attachments.
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