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IRS Disallows Loss on Disposition of Building Structural Components


5/9/16

Synopsis

In a partially redacted field attorney advice memo (FAA 20154601F), the IRS concluded that a taxpayer was not entitled to the full amount of losses related to dispositions taken under the prior-Prop. Treas. Reg. §1.168(i)-8. The IRS determined that the taxpayer incorrectly applied the proposed section 168 regulations and the taxpayer’s records did not fully substantiate the estimated loss.

Issue

In an unidentified year, a taxpayer sought to change its accounting method to recognize a loss on the disposition of structural building components, in accordance with Prop. Reg. §1.168(i)-8. The taxpayer’s consultants prepared a statistical sampling study to estimate the adjusted basis of the total population of buildings that was disposed of but was still being depreciated for tax purposes.  The taxpayer’s cost history included asset location, description, tax life, depreciable cost basis, bonus depreciation elections, accumulated depreciation, placed in service dates, etc.

The study concluded that the taxpayer was entitled to a loss on the disposition of numerous structural components.

Under Prop. Reg. §1.168(i)-8, a taxpayer can claim a loss on the disposition of a depreciable asset (or portion of a depreciable asset) that it has not fully depreciated at the time of the disposition.  Under Rev. Proc. 2014-54, a taxpayer can make a late partial disposition election for tax years between January 1, 2012, and January 1, 2015, by filing a Form 3115, Application for Change in Accounting Method.  The proposed regulations apply to property that a taxpayer depreciates under MACRS.  A taxpayer that disposes of an asset (or a portion thereof) that is MACRS property can claim a loss in the amount of the adjusted depreciable basis of the asset or portion of the asset at the time of the disposition. Each building, including its structural components, is an asset. An improvement or addition that a taxpayer placed in service after it placed the asset in service is a separate asset.

The IRS Office of Chief Counsel concluded that the taxpayer was not entitled to the full amount of the disposition loss estimated in its statistical sampling study. The IRS maintained that the taxpayer incorrectly applied the proposed regulations by identifying disposition losses when the taxpayer installed new assets but did not establish that the taxpayer:  (1) had actually disposed of assets when it installed a new asset; or, (2) had adjusted depreciable basis in a building, leasehold improvement, or single asset account at the time of the disposition that would give rise to a disposition loss.  Specifically, the IRS stated that there seemed to be instances in which the new item was not a replacement, but was instead a new item related to an expansion.  The IRS also noted instances in which the taxpayer replaced an asset and there was no remaining basis left in the underlying building.

Further, the IRS said, the taxpayer used an incorrect method to calculate the disposition loss where it compared the cost basis of new assets with the taxpayer’s oldest assets without making adjustments to take into consideration the fact that the old assets were of a different type or quality.

What Does CohnReznick Think?
While taxpayers can no longer make late partial disposition elections, taxpayers still have the ability to calculate and recognize partial disposition elections on current-year disposals. These losses may be available where a taxpayer replaces a substantial structural component of a building (for example – a roof) and is required to capitalize that amount under the tangible property regulations. In such a situation, the taxpayer is allowed to estimate its loss on partial disposition, but must use IRS prescribed techniques which take into account whether the taxpayer has basis in the underlying partially-disposed asset (the building system) and whether the replacement property is of a similar quality and/or type. While the estimation technique could be complex in certain situations, taxpayers should not shy away from taking losses when available. Such losses could create a significant tax benefit in the form of accelerated deductions.

Contact

For more information, please contact Richard Shevak, Director, at richard.shevak@cohnreznick.com or 862-245-5029.

Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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