CPAs! New IRS Regulations on Partial Disposition!
Partial Disposition Prevents Simultaneous Depreciation
Partial disposition refers to the disposition of part of a larger asset separately from the remainder of the asset, typically when a portion of the asset is replaced before the entire asset is depreciated.
The IRS adopted partial disposition rules for Modified Accelerated Cost Recovery System (MACRS) assets with the adoption of T.D. 9689 in August 2014. T.D. 9689 updates and clarifies temporary rules issued in 2011.
Replacing items such a roof or a HVAC system and capitalizing those costs results in simultaneous depreciation. The old component is still depreciated as part of the overall building asset costs while the new one is depreciated separately.
The new regulations allow for removal and disposition of the replaced component, resulting in an immediate write-off of the non-depreciated portion of the disposed component. The challenge is – how do we determine the component’s basis?
The most defensible approach is to conduct a cost segregation study that divides up the full asset into individual component costs, and prorates them so that their sum is equal to the original basis of the entire building. Unfortunately, this can be cost prohibitive if all you need is the cost to dispose of one component.
Disposition and Cost Segregation
Any capitalized tangible asset, ranging from office equipment and computers to buildings and facilities, will eventually be disposed on the federal tax asset schedule. The depreciation period of that asset is determined by the MACRS asset class into which it falls.
If a component of an asset is replaced early in the life of the asset, a greater depreciation deduction (and associated tax savings) is available through these new partial disposition regulations. In essence, the longer the gap is between the date of disposition and the scheduled full depreciation of the asset, the greater the tax savings through partial disposition.
Although a cost segregation study is typically used to identify all assets suitable for accelerated depreciation, it should now also include the cost breakdown of the remaining 39-year property. This way, if a component of the building (i.e. the roof) is later replaced, the original cost seg study can be leveraged to identify the components basis, with no additional cost incurred.
Timing Is Important
If a component was replaced on or after January 1, 2014, the partial disposition election must be taken on the originally filed tax return (including extension) of the year that it was replaced. In other words, the taxpayer cannot elect a change in accounting method in future years. However, if the asset was replaced prior to 1/1/14, the taxpayer is still allowed to complete a cost segregation study and recapture this additional depreciation some tie in the future.
To be clear, going forward this is a one-shot opportunity. The current year’s tax return must elect the partial disposition, or forego the opportunity forever. There is no provision for late partial distributions in future tax years, so this is a “use it or lose it” proposition.
The tax savings could be large, especially if there are multiple assets that are eligible for partial distribution status. A good cost segregation study can help identify these assets and maximize the deduction on this year’s return.
A thorough understanding of the new regulations, along with an efficient method of performing a cost segregation study, if necessary, gives CPAs an advantage over competitors. Titan Echo helps CPAs make an initial cost segregation assessment for their clients cost effectively. This screening capability eliminates the risk of paying for a full cost segregation study that may not be warranted.