Transcript (1) Entire building. - Delaware Law School

Tangible Property RegulationsLandlord Tenant Issues.
• The new tangible property regulations present the
opportunity to expense tenant improvements if the
expenditures are not required to be capitalized under
the restoration, adaptation, betterment, or
improvement (“R.A.B.I.”) tests.
• Expenditures required to be capitalized create
opportunity for partial asset disposition.
• These regulations provide a double benefit to many
taxpayers as the repair deduction would generate tax
benefits at ordinary rates while the future gain from
sale would be taxed at capital gains rates with less
recapture.
Leased Buildings – UOP
• Lessor – entire building is the UOP
– For multi tenant buildings, UOP is the entire building.
– One building built at different times is one UOP.
– Two or more separate buildings built at the same time are
separate UOP.
• Lessee – UOP is portion of the building subject to the lease.
– For multi tenant building the UOP is their space
– If the whole building is leased UOP is entire building
• Amounts paid for tenant improvements are not a separate
unit of property. [1.263-3(e)(4)]
– This conclusion is important in the measurement comparison
for “RABI” criteria.
• If the TI class life was subsequently changed, from an
impermissible life to permissible lifeor as a result of a cost
seg. that will create a separate UOP.
1.263(a)-3(e)(2)(v)
UOP for Leased Buildings
• (v) Leased building
– (A) In general.— In the case of a taxpayer that is a lessee of all or a portion of
a building (such as an office, floor, or certain square footage), the unit of
property ( "leased building property") is each building and its structural
components or the portion of each building subject to the lease and the
structural components associated with the leased portion.
– (B) Application of improvement rules to a leased building.— An amount is
paid to improve a leased building property under paragraphs (d) and (f)(2) of
this section if the amount is paid for an improvement, under paragraphs
(j){betterments}, (k){restorations}, or (l){adaptations} of this section, to any of
the following:
• (1) Entire building.— In the case of a taxpayer that is a lessee of an entire building, the
building structure or any building system that is part of the leased building.
• (2) Portion of a building.— In the case of a taxpayer that is a lessee of a portion of a
building (such as an office, floor, or certain square footage), the portion of the building
structure subject to the lease or the portion of any building system subject to the lease.
Observations and Discussion
• The UOP for a landlord is the whole building, building
structures and/or building systems.
• Since tenant improvements are not a separate UOP
– The result will be that many landlord tenant
improvements, beyond the initial tenant improvements,
will be classified as repair and maintenance expense.
• Exception would be adaptation or betterment.
• Examples of TI that would be adaptation or
betterment: Retail or office space to medical facility.
Example- from the regs
• HVAC system includes 10- roof mounted units.
• The roof mounted units are not connected and have
separate controls and duct work that distribute the air
to different spaces in the buildings interior.
• The entire HVAC system including all of the roof
mounted units comprise a building system.
• 2 of 10 units replaced, even if more efficient it is not a
material addition or a material increase in efficiency.
• Question: How are we to judge the efficiency of the
old units? Comparison to new units? We need more
information to make these determinations.
Additional example
• Large multi tenant strip mall, one building so one
UOP. 25% of the sq footage is a grocery store
that becomes vacant. New grocery store will
lease space but wants landlord to reduce square
footage to 15% of building and change layout of
the store. Expenditures of $400,000 are incurred
by landlord to “refresh” the space.
• What is the outcome? Would it matter if it was
something other than a grocery store? Would it
matter if it was a Whole Foods and higher quality
upgraded materials were used?
1.263(a)-3(f) Rules for Improvements
to Leased Property
• 3) Lessor improvements
• (i) Requirement to capitalize.— A taxpayer
lessor must capitalize the related amounts,
that it pays directly, or indirectly through a
construction allowance to the lessee, to
improve, a leased property when the lessor is
the owner of the improvement or to the
extent that section 110 applies to the
construction allowance.
Leases with Section 110
• Sec 110 allows tenants to exclude from income any amount
received as a construction allowance or a rent reduction from the
owner/landlord.
• In making the decision to capitalize or treat as R&M check the lease
for 110 language.
• Landlord must capitalize expenditures for TI under a 110 lease even
if it is not a betterment adaptation or restoration.
• Recommendations to clients:
– Do not refer to Section 110 in the lease agreement. State that the
landlord owns the improvements.
– Do not provide lease allowance with no obligation to spend, otherwise
landlord has an intangible
Common Area Maintenance and TPR
• Is it a tenant paid repair or a landlord paid capital
expenditure?
• How does the TPR affect the CAM charges to tenants?
• Expenditures to resurface a parking lot may be treated
as repairs in the future and passed on in the CAM.
• Certain roof work that previously would be capitalized
will be R&M, for example replacing the roof
membrane.
• Landlord and tenant may consider amending the lease
to make it clear what is to be included in CAM.
Removal Costs and Tenant
Improvements
• Method change #21 enables a taxpayer not to have to
capitalize removal costs associated with an
improvement. If not done in 2014 can still do for your
clients.
• Allows taxpayers to expense removal costs when
demolishing tenant improvements. Must also have a
PAD on the tenant improvements disposed of.
• Taxpayers should ask the contractor to break out the
demolition and removal costs on the invoice.
• Need to ask clients more questions about work done to
their property.
Partial Asset Dispositions (PAD)
• Prior to these regulations there was no ability
to take a loss on partial asset dispositions.
• Late partial dispositions were permitted in tax
year 2014 with significant tax savings for many
taxpayers.
• Scrubbing of depreciation and prior partial
asset dispositions, a unique opportunity for
2014 returns.
Partial Asset Disposition (PAD)
and the “Rule of One”
• Taxpayers need to have one of every asset on its
books, but can choose to have more than one.
• Example
– TP is a landlord and replaces all of the windows in the
building
– TP must capitalize the new windows as it is a
restoration under the new standards.
– TP can do a PAD for the removed windows but is not
required to.
– If the window expenditure was not a restoration and
instead a R&M expenditure no PAD can be done.
Rule of One -continued
• You do not have to have basis in an asset, or
part of an asset, in order to have “one”
• If the tenant installs a new roof that is
capitalized then the landlord can do a PAD for
the original roof that is already on the
landlords books.
• Similar outcome if a new tenant pays for and
does their own tenant improvements (TI),
landlord can do a PAD for the previous TI.
Partial Asset Dispositions-continued
• If you have a capitalized improvement you
need to consider the PAD.
• Calculation of PAD? IRS says use any
reasonable method.
– Cost segregation study
– Discount the cost of a replacement component to
its placed in service year using the Producer Price
Index (PPI) (not for a betterment or adaptation)
– Resource for finding PPI indexes: www.kbkg.com
PPI rollback- limitations
• Be cautious in using this method when a
building component is replaced within 10
years of a buildings acquisition.
• This method does not account for the
condition of the building component at the
time of acquisition and may overstate the loss.
• If building was purchased at a discount or
involves a basis adjustment an overstated loss
may result using PPI.
Example-New windows in entire building
• A building was acquired three years ago. $200,000 is
incurred to replace all the aluminum windows.
• Discounting back three years the value of the windows is
$186,000. Since the windows were not new when the
building was purchased a condition factor must be applied.
• Example given on kbkg.com website states the aluminum
windows had a 20 year life and had 3 years of life at
purchase, a condition factor of 27% was used reducing the
PAD to $50,220.
• KBKG.com has a software tool that you can purchase that
incorporates the condition factors and the effective age of
components.
• Different conclusion if building was newly constructed
when placed in service.
Discussion/Questions
• Analyze future expenditures and determine if
there is an improvement to be capitalized or
R&M to be expensed. Sounds simple enough.
• Use flowcharts to help in decision making.
• How will the client or the clients bookkeeper
know how to classify?
• We will need to ask many more questions of
our clients to make these decisions.
• Opportunities? Problems? Suggestions?