TPRs, Real-World Small Potatoes Situation, Rental Property

[TomJ]

Simple situation on the surface. Yet it makes it clear that I have know idea how to handle even the simplest situation. Maybe if we do a few of these, we can reach consensus on how to treat the common stuff we're going to deal with. Here goes:

Client has one rental property (single family house, $70k basis, $50k allocated to the building and being depreciated). In 2013, client replaced the only A/C unit for the house ($2400) and purchased a used refrigerator ($195) to replace a broken refrigerator. Both the old A/C and the old fridge were purchased with the house back in 2002. The taxpayer keeps no books, has no capitalization policies, and I am not an accountant. In 2013 when these purchases were made, I discussed them with the client and we decided that both should be capitalized and depreciated over time as they were not repairs (in my thinking back then), they were replacements / improvements and both had a useful life of greater than 1 year.

So now it's 2014. Under the new regulations, should both the A/C and the refrigerator have been capitalized? Should the old A/C and refrigerator have been treated as partial dispositions of the original property? Since the DMSH and STSH didn't exist back then, they don't apply. I suppose the RMSH could apply to both since the life of an A/C and fridge are surely less than the 27.5 years over which they were being depreciated as part of the house. So is the answer to file a 3115 adopting the regs related to the RMSH, and taking a 481(a) adjustment for the remainder of the depreciation in 2014? What about the rest of the new regs? Do they have to be adopted in the 3115 too even though they don't apply right now? The definition of incidental materials & supplies could certainly apply in the future right? I'm sure the others could too.

So confused as to what I should do. And this is (I think), one of the simplest cases I have to deal with this year. If you have a better understanding that I do and can shed any light on this, it would be greatly appreciated.

[BHoffman]

My understanding is that we are not REQUIRED to make adjustments for prior years. We are ALLOWED to make prior year adjustments. If we choose to make prior year adjustments, then we file form 3115 with the 481(a) adjustment. If we choose not to make prior year adjustments, then we observe the TPRs prospectively starting on Jan 1, 2014.

If our rental owner clients have TPR transactions in 2014 (and going forward) and they want the benefit of the election, then my understanding is that we make the election and record the transaction accordingly. If our rental owner clients do not have any TPR transactions in 2014 (and going forward), then we don't make any TPR elections for that year.

[Burke]

I suppose the RMSH could apply to both since the life of an A/C and fridge are surely less than the 27.5 years over which they were being depreciated as part of the house. So is the answer to file a 3115 adopting the regs related to the RMSH, and taking a 481(a) adjustment for the remainder of the depreciation in 2014?

Forgive me if I am wrong, but I interpreted this statement to mean you may have depreciated the fridge over 27.5 years? If so, that would be incorrect. 179 was not available to rental property in 2013 for furniture and fixtures, but the useful life of 5 years was. Was the A/C unit central for the whole house?

[TomJ]

I'm currently depreciating the a/c and fridge that were purchased in 2013 over 5 years. I was referring to the original a/c and fridge, which were part of the originally purchased property. Since they were part of that unit of property and not purchased separately, they were being depreciated over 27.5 years along with the building. To be clear, they were not separate line items on the depreciation schedule. They're were just part of the depreciable basis or the purchased property as a whole.

The A/C is the condenser unit that sits outside the house and provides central a/c to the whole inside of the house.

BHoffman - your understanding is in direct conflict with my understanding. The DMSH and STSH are the only items that can be adopted prospectively (since they are annual elections, not accounting method changes) as far as I know. Partial dispositions, material and supply regs, RMSH, and a world of other things I don't understand need be applied retroactively with a 481(a) adjustment taken in 2014 if they change the way tangible property was capitalized or expensed in the past. I know AICPA was begging the IRS to allow small taxpayers to adopt the TPRs prospectively rather than retroactively, but to my knowledge, the IRS has not issued that guidance. But this is good. One of us is not correct (I hope it's me!), so I'd love the input of others.

[TXEA]

TomJ -

Unless this was a window unit A/C, then it is classified as 27.5 year property. This would be change code 7 on Form 3115 to change from an improper to a proper method.

Now, as to the replacement of the A/C, you might qualify via the partial asset dispositions rules to deduct the cost of the old a/c. There are special rules released in late 2014 (can't find the cite right now) on how determining the basis in the old is done. I typed an example in another thread. The ability to look back for this adjustment is allowed one time only in 2014.

Further, some have come to the conclusion that if we don't do this for 2014, that the IRS could potentially disallow the depreciation on the new A/C since the old was not disposed. I do not think this will happen, but it is another one of the uncertainties with regards to these infernal regulations.

[TomJ]

The client didn't replace the entire HVAC system (duct work, blower, electrical, etc). He just replaced the condenser unit outside the house. You're saying that should be depreciated over 27.5 years? I had considered it more like an appliance since there's no way this thing will last anywhere near the life of the building or the HVAC system as a whole. Either way, that's a side issue that wasn't the point of the original question.

Let's say the a/c unit was depreciated properly under the old rules without regard to what those old rules were. Fridge as well. Under the new rules, both of these could be expensed right (fridge as a material & supply? and a/c as routine maintenance of the building since its life is substantially less than the building as a whole?)? If that's correct, are we obligated to file 3115 for a change in accounting method and take a 481(a) adjustment for the remaining deprecation, or is that a choice? If we don't do that now, are we losing the ability to use the new regs in the future and therefore using impermissible accounting methods because we're unable to use the new regs?

What about the partial disposition of the old a/c and fridge from the building? I understand there's a way to do that and I'm not asking what it is or how to calculate it. Are we obligated to do it, or is it a choice?

What are most people doing with stuff like this? Just pretending the new regs only apply going forward and that no accounting method changes are necessary? I would love to be able to do that, but isn't there tax preparer liability exposure in making that decision?

[Burke]

I am totally confused. I thought these new regulations did not go into effect until 2014. They were available in 2013?

[S T]

Burke you are not alone! Likewise, I am also confused,

I believe that the Regs allow a correction on lookback to 2012 - 2013 via Form 3115, but then I don't have any confidence in what I am posting here.

I am not anticipating any corrections for 2012 and 2013, and hopefully am just moving forward for 2014, but then I am not confident of that either - hoping for NO Form 3115 and maybe only a few of the Safe Harbor Elections 1.263 (F) or (h).

I just don't know why this has to be so complicated!

Sandy

[TomJ]

New rules went into effect for 2014. As I understand them, if you're changing an accounting method for 2014 to abide by the new regs, you have to file form 3115 and calculate any 481(a) adjustment that results. For example, if you previously capitalized something in 2010 that could have been expensed under the new rules, then in 2014, you'd file form 3115, modify your accounting method to reflect the change from the old regs to the new regs, and take the remaining depreciation as a 481(a) adjustment in 2014. Without making the adjustment for previous years, you'd be using one accounting method for pre-2014 purchases and another for post-2013 purchases which isn't allowed.

I would be thrilled to find out that's not the right interpretation, but even the AICPA and the states see it that way and have begged the IRS to relax the requirements at least for small taxpayers. See: http://www.aicpa.org/Advocacy/CPAAdv...pair-Regs.aspx. No response from the IRS.

[S T]

TomJ,
Well if your interpretation is correct, I am just hoping I have no 481(a) adjustments - You truly stated it better than I did, but then see I already stated I am so confused on this F-3115. The lookback I think is what is giveng some concern, I only want to move forward

Sandy

[Gretel]

I am concerned about the look back as well. I am also trying to muddle through all seminar and other information to come up with the right decisions for my clients.

Here are my thoughts.

Any asset purchased no matter the amount, should not be effected since you only can deduct if such procedures were in place in the beginning of the year. This is not a form 3115 issue anyway. I doubt that I have any client were I capitalized a repair that was a true repair (also qualified under the new regs). They were expensed. The only repair I ever capitalized was a total engine rebuild for a truck or a new roof.

Of concern are new potential clients were such things might have happened. In some instances you would need to go back several years. The client type that would be most effected in my mind are farmers, they write everything down as expenses.

What I am concerned about is this: down the road you acquire a new client. From now on we will need to ask for all years of tax returns starting in 2014 if form 3115 was ever filed. How else would we know? This form is filed in the year the change actually occurs.

So f.e. if in 2020 it would make sense to adopt the routine maintenance safe harbor but it was not in issue before then that is the year to file form 3115. Question is: How would I know if this client wasn't with me since 2014? I am not going to look at his books for all the missed years and I am sure no client would want to pay for this.

I hope, like so many of us, that there will be a relief for real small taxpayers.

[Lion]

That roof may well be a repair. When your client learns from his friends how much money they got back for 2014, you may wish you'd filed the 3115. It's a CYA and not just a form your clients need. (And, I don't understand it either, especially not the new 500 pages from 16 January 2015.)

[TXEA]

As a caveat, I am learning this as I go, so please research this yourself and correct me if you find an error.

For reference, See Rev Proc 2014-54 Section 6.33 - late partial disposition election.

The issue on the a/c is that there is a potential for a late partial disposition. When the condenser of the old unit was replaced, the new regs allow us to look back and dispose of the "adjusted cost basis" of the old one. This is allowed one-time for 2014 and is done via an accounting method change (the best I can tell).

TomJ - as to the 5 year class life you used for the condenser unit, I do not think of it as an appliance. I would have depreciated over the life of the residential property. These issues have been debated for years on this board.

Finally back to your other question, relate this to the new rules. If your example was for 2014 costs, and depending on the unadjusted cost basis of the structure, the condenser and the fridge might be a low enough expense that your taxpayer could elect the Small Taxpayer Safe Harbor (STSH). With this election, the total cost of M & S, repairs, and actual improvements can not exceed the lower of 2% of the unadjusted cost basis of the structure or $10,000. To qualify, the unadjusted basis of the building must be 1 Million or less and taxpayer must average 10 million or less average gross receipts in the preceeding tax years.

[Gretel]

That roof may well be a repair. When your client learns from his friends how much money they got back for 2014, you may wish you'd filed the 3115. It's a CYA and not just a form your clients need.

What is CYA?

I know that some attorneys already prepare for lawsuits against taxpreparers who do not file forms 3115 (this includes going back to 2012) to save our clients big bucks. While this seems very scary I doubt that anyone of the people who bother being part of this board has enough at stake that an attorney would even bother. I surely keep educating myself, make the best decision possible and then move on. There is no way I drive myself nuts over potential consequences. It is what it is and I would defend my position. If have doubts I will file for an extension in the hope that more guidance will be available later in the year.

[Lion]

CYA, to be a bit more polite is Cover Your Butt. Preparer penalties are on the line, and even lawsuits. Do you advise your clients and let them choose to do nothing or something instead of making choices for them? Extensions might give us time to see what direction the IRS is heading, are they auditing businesses without 3115s, for instance. Once in an audit, it's too late for 3115.