CPAs Should Urge Commercial Property Owners to File Forms 3115… Despite IRS “Relief”

Posted by Don Warrant on 2/19/15 11:41 AM

Benefits of filing Form 3115 include IRS audit protection and valuable tax savings from prior-year repairs and dispositions.

Revenue_Procedure_2015-20To file Form 3115 or not. That is the question of the week.
Our answer: Owners of commercial property should continue to file a Form 3115 with their 2014 tax returns with limited exceptions (see sidebar), even though it may require filing extensions to allow adequate time to complete and file a Form 3115.

Sure… on its face, Rev. Proc. 2015-20 appears to be a reason to celebrate. Small taxpayers can now choose to make changes in accounting methods for tangible property without filing a Form 3115, as long as they use a “cut-off” method (i.e., for tax year 2014 and going forward).
Whew! Tax preparers can breathe a huge sigh of relief as a looming mountain of paperwork disappears in a puff of smoke. Right? Not really.
Filing a Form 3115 actually provides a number of protections that your client is waiving by taking advantage of this so-called “relief.”

  1. IRS examination protection. When taxpayers file Forms 3115, they receive IRS examination protection for their accounting method treatment for all prior tax years. By taking advantage of the exception for small taxpayers, your client waives that protection. For clients who may have aggressively expensed items in prior years under their old methods, that protection is likely worth the cost of preparing the Form 3115 (at most a couple of hours of your time). You still need to perform the work and documentation as to the methods and elections that apply to the 2014 tax year.
  1. Current deductions of previously capitalized items. Your client could be missing out on some taxpayer-friendly provisions within the Tangible Property Regulations if they choose to use the “cut-off” method. Many owners of commercial real estate actually have been fairly conservative in the past with regard to capitalization of costs in prior years. They could have tens or even hundreds of thousands of dollars in remaining tax basis that, under the new unit of property rules, are now eligible for current deductions. Without a method change filing, those deductions are off limits.
  1. Late partial disposition. As we’ve said in prior posts on "late" partial dispositions, taxpayers have a one-time opportunity to recognize partial dispositions of property that occurred in prior years on 2014 tax returns—and only if they file a Form 3115. Your client is waiving this opportunity if they file their return without a Form 3115.
  1. Recognize an unfavorable section 481(a) adjustment over a four-year period. If you have a commercial real estate client who aggressively expensed items in prior years that now must be capitalized and depreciated, then that client will be better off by coming into compliance now and spreading the hit over a four-year period. If the IRS finds those issues upon examination, they will require an immediate increase in income.

Resistant Clients? Have Them Sign a Waiver

What if your client has heard about this so-called good news from the IRS and demands to skip the Form 3115? We recommend that you ask your client to sign a written acknowledgement of the following:

  • They waive IRS exam protection for the item for all prior tax years.
  • They forego any tax benefits associated with a method change for repairs or for dispositions—including the expiring “late” partial disposition election.
  • Filing the return without a Form 3115 is irrevocable once the return is filed.
IRS issued Revenue Procedure 2015-20 revising Revenue Procedure 2015-14 Of course, we believe that your commercial real estate clients will see the light when you present all the benefits that can come from digging into their fixed asset and depreciation schedules to uncover tax savings while bringing them into compliance with the Tangible Property Regulations. If you have questions about whether filing Form 3115 is right for your client, contact us to learn how our accounting method change specialists can help.

Tags: commercial real estate, tangible property regulations, Don Warrant, Form 3115, fixed asset, Revenue Procedure 2015-20

New Year’s Resolution for Landlords: Clean-Up Fixed Asset Schedules and Find Tax Benefits

Posted by Don Warrant on 1/14/15 9:13 AM

Landlords should consider whether tenants have removed portions of building components as a result of tenant improvements.

Fixed_Asset_SchedulesFor many, ringing in a New Year includes a list of resolutions to reorganize and clean out unwanted items. For landlords, cleaning up fixed asset schedules could be the best resolution of all. We have identified a common trend with commercial real estate leases that has benefitted many of our clients.

Partial Disposition for Landlords

Many commercial leases require the tenant to make leasehold improvements to the building. Thanks to the new tangible property regulations, when the tenant replaces a building component, the landlord has an opportunity to abandon the original component and write off the remaining tax basis.
For example, say a building tenant replaced the roof in 2013. The new roof would be capitalized on the tenant’s books and will never appear on the landlord’s fixed asset records. But since the old roof is on the landlord’s books, the landlord can file a method change to make a “late” partial disposition election and recognize a loss for the remaining tax basis in the old roof.
There is a danger to landlords in overlooking this opportunity to clean up their fixed asset schedules. If the landlord were to sell the building and have assets on the books that have actually been disposed of, that building owner could potentially have a depreciation recapture—which is taxed as ordinary income--on an asset that the client no longer owns. 

Planning Opportunity

How do you identify these opportunities for your commercial real estate clients? Start by reviewing lease agreements to identify those that require the tenant to make improvements to the building.
Next, review what improvements have been completed by the tenants that would have resulted in the removal of building components. If a tenant has made an improvement that resulted in the removal of a portion of a building component, then the landlord is eligible to recognize a loss for the remaining tax basis.

Act Now to Claim Deductions for Prior Year Partial Dispositions

Remember that 2014 is the only year in which taxpayers can file a method change to make a “late” partial disposition election and recognize a loss for the remaining tax basis of portions of building components disposed of in prior years. So once the 2014 extension deadline passes, the building owner loses forever the opportunity to write off portions of building components abandoned in prior years.
Time is also of the essence going forward. As your client’s tax adviser, you will need to stay on top of tenant improvements each year so that your client can recognize the abandonment of portions of building components in the current and future years on a timely filed original return. The election cannot be made on an amended return.

Give Yourself A Breather

CSP360 Deep Dive Program This clean-up process will take time, since your client may not be readily aware of all the improvements that tenants have made in 2014 and prior years. Therefore, we recommend filing an extension for the 2014 tax year to give yourself more time to identify and recognize partial dispositions of building components.
If you have questions about how your commercial landlords can take advantage of this fixed asset clean-up process, contact us to learn how we can help.

Tags: Don Warrant, tax saving opportunities, fixed asset

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