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IRS Finds Fault with Taxpayer's Statistical Sampling Study; Structural Component Disposition Loss Reduced.

(Parker Tax Publishing December 10, 2015)

A taxpayer was not entitled to the full amount of a structural component disposition (SCD) loss estimated in its statistical sampling study. The proposed regulations under Code Sec. 168 that the taxpayer used were incorrectly applied, an incorrect method was used to calculate the SCD loss, and the taxpayer's records did not fully substantiate the estimated SCD loss. FAA 20154601F.

Background

Under Prop. Reg. Sec. 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.

Under the proposed regulations, when a taxpayer disposes of a complete asset, the adjusted depreciable basis of the asset at the time of its disposition determines the taxpayer's gain or loss on the disposition. A taxpayer that disposes of a portion of an asset can use any reasonable method to determine the unadjusted depreciable basis of the disposed of portion or portions. The taxpayer must then determine the adjusted depreciable basis of the asset by applying the depreciation method, recovery period, and convention applicable to the asset and accounting for the portion of additional first-year depreciation deduction claimed for the asset that is attributable to the disposed of portion.

OBSERVATION: Prop. Reg. Sec. 1.168(i)-8 was finalized by T.D. 9689 (8/14/14) as part of the final tangible property regulations. These final regulations were not in effect during the year at issue.

In an unidentified year, a taxpayer, who was eligible to use the proposed Code Sec. 168 regulations, sought to change its accounting method to recognize gain or loss on the disposition of building structural components in the year of disposition, in accordance with Prop. Reg. Sec. 1.168(i)-8. The taxpayer had a statistical sampling study prepared to identify assets (or portions of assets) that it had disposed of but that it was still depreciating. The study concluded that the taxpayer was entitled to a structural component disposition loss (SCD loss).

The preparer of the statistical sampling study relied on the taxpayer's schedule of all buildings it owned or leased at each of its locations. The preparer also relied on the taxpayer's fixed asset databases, which included building and personal property assets at the taxpayer's locations (i.e., cost histories). The cost histories included asset location, description, tax life, depreciable cost basis, bonus depreciation elections, accumulated depreciation, placed in service (PIS) date, and net tax value. The taxpayer did not use multiple asset accounts. The accuracy and detail of the cost histories varied.

Analysis

The IRS Office of Chief Counsel (IRS) advised that the taxpayer was not entitled to the full amount of the SCD loss estimated in its statistical sampling study. According to the IRS, the taxpayer incorrectly applied the proposed regulations by identifying SCD losses when the taxpayer installed new assets without establishing 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 SCD loss.

In addition, the IRS said, the taxpayer used an incorrect method to calculate the SCD loss when it compared the cost basis of new assets with the taxpayer's oldest assets because the assets were not of the same type and may not have been disposed of. Finally, the IRS noted, the taxpayer's records did not fully substantiate the estimated SCD loss.

The IRS advised that, under either the FIFO or modified FIFO method of identifying the partially disposed of asset, a taxpayer must treat the asset with the earliest PIS year that has the same recovery period as the partially disposed of asset. The preparer' study incorrectly relied on the FIFO method, the IRS said, by ignoring single asset accounts with no remaining adjusted basis. If a sample included pre-MACRS assets or ignored zero adjusted depreciable basis assets, the IRS noted, the taxpayer cannot claim a loss on the disposition or partial disposition of the asset.

Under Prop. Reg. Sec. 1.168(i)-8(f)(2), a taxpayer can use a reasonable method to determine the unadjusted depreciable basis of the disposed of portion of an asset or an asset in a multiple asset account. In the instant case, the IRS observed, the taxpayer did not account for its assets in multiple asset accounts and, therefore, in the case of a full disposition of an asset, the adjusted depreciable basis of that asset at the time of its disposition determines the SCD gain or loss. The use of a reasonable method to determine an asset's adjusted depreciable basis can only be used if the taxpayer partially disposed of an asset. According to the IRS, the taxpayer's various building and structural component assets cannot be treated as though the assets are in a multiple asset account for the purpose of determining the assets' adjusted depreciable basis. The study, the IRS noted, identified groups of the oldest assets as the disposed of assets by comparing a new asset's cost basis to the oldest assets' cost basis. The IRS advised that, to the extent this method was applied, the sample should be disallowed in calculating the taxpayer's SCD loss.

For a discussion of calculating gain or loss on a qualifying disposition of an asset, see Parker Tax ¶94,328. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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