• New Campaigns Announced

On March 13, 2018, the Large Business and International (LB&I) Division of the Internal Revenue Service (IRS) announced five new compliance campaigns. The new campaigns continue the IRS’s move to issues-based examinations that focus on risks identified in the field. The move to issues-based examinations enables LB&I to target resources to specific issues for examination. Of particular note, the IRS has identified one aspect of the tangible property regulations implemented by numerous taxpayers—the partial disposition election for buildings. 

In 2013, following a nine-year process that included proposed, re-proposed, and temporary regulations, the final tangible property regulations (TPR or the Repair Regulations) were released. The Repair Regulations provide guidance regarding costs associated with the acquisition and repair and maintenance of tangible property. Generally, these regulations are effective for taxable years beginning on or after January 1, 2014. 

Many taxpayers struggled with the task of implementing these regulations through the various iterations of the rules. The challenge of implementation is demonstrated by the 200-page audit technique guide issued by LB&I to assist IRS Exam teams in auditing companies’ implementation of the Repair Regulations. Approximately 18 months after the release of the behemoth audit technique guide, LB&I has identified a single area of exposure—the partial disposition election provided in Treas. Reg. § 1.168(i)-8. This new campaign focuses on ensuring that companies accurately recognize the related gain or loss on the partial disposition of such building property.

  • Background on Partial Dispositions

The final Repair Regulations provide specific rules for determining gain or loss upon the disposition of Modified Accelerated Cost Recovery System (MACRS) property under Section 168, determining the asset that was disposed, and accounting for partial dispositions of MACRS property. The disposition rules are included in Treas. Reg. § 1.168(i)-8, and these rules apply to a partial disposition of an asset. 

The preamble accompanying these regulations uses a roof as an example of a partial building disposition. The rules permit taxpayers to claim a partial disposition when a building’s structural component is disposed of, and this partial disposition treatment is available without identifying the component as an asset prior to the disposition. The final Repair Regulations allow a partial disposition election with respect to the disposition through transfer, withdrawal or retirement. The final TPR includes examples of partial dispositions and special rules that address the initial election as well as any subsequent revocation of a partial disposition election. 

Importantly, the final regulations retained the rules in the 2013 proposed regulations for determining gain or loss with such dispositions. Consequently, when an asset is disposed of by sale, exchange or involuntary conversion, the gain or loss must be recognized. If an asset is disposed of by physical abandonment, loss is recognized equal to the asset’s adjusted depreciable basis at the time of the abandonment. If the abandoned asset is subject to non-recourse debt then the asset is treated as if the asset was transferred in a sale. Further, if disposal involves transfer to a supplies or scrap account, then a loss is recognized equal to the excess of the asset’s adjusted depreciable basis over its fair market value at the time of disposition. 

  • Eversheds Sutherland Insight

The partial disposition provisions include a maze of special rules and elections. Moreover, implementation of these rules was complicated by a protracted guidance process that included a range of proposed, re-proposed and temporary regulations. As a result, it should not be surprising that some taxpayers have found implementation challenging. Recent IRS Exams have taken advantage of the challenging circumstance and have involved a close review of partial dispositions, focusing on both procedural and substantive aspects of the partial disposition election. Recent IRS Exams have also questioned whether appropriate gain or loss was determined. 

Following the announcement of this campaign, companies that claimed significant partial dispositions should review these items carefully to confirm both that proper elections were made and that the correct amount of gain or loss has been reported. Any company that is being examined with respect to its treatment of tangible property should anticipate that LB&I will review its treatment of partial dispositions. Partial dispositions tend to be more common among companies that are updating or improving facilities, including, for example, retailers, and restaurants. 

More importantly, although this campaign identifies a single issue involving the Repair Regulations, other campaigns regarding the TPR should be expected. The scope of the regulations, as well as the number of taxpayers affected by these rules, suggests that LB&I will closely scrutinize TPR implementation. The treatment of partial dispositions is just one of a number of issues that the IRS will likely identify for its agents to review.