Taxpayers often overlook “partial asset dispositions.” Their tax advisers do too.
This may be due to it being a depreciation issue that seems unimportant. It may also be that the partial asset disposition is a relatively new concept.
Regardless, partial asset dispositions can save taxpayers quite a bit in taxes (it is a timing issue, but it also helps avoid recapture tax–which is not just a timing issue).
The IRS recently released a practice unit that provides guidance for partial asset dispostions, which provides an opportunity to consider what records are needed to support a partial asset disposition.
About Partial Asset Dispositions
When you replace a component for a building you own, you have to get rid of the existing component. This is true whether it is a roof, flooring, equipment, etc. for the building.
Prior to the 2014 tangible property regulations, taxpayers would do an abandonment study to identify the property that was replaced. This allowed the taxpayer to take a Sec. 165 loss for the property. This is how it should work. Taxpayers should be able to recover the investment for the abandoned property at the time it is disposed of.
But the IRS often challenged abandonment studies. This was in part due to the loss being reported like any other type of tax loss. The IRS had no real way of discerning which losses to examine, so it would just pull the tax returns for audit. And, when examined, losses (of any type), are often disallowed by the IRS on exam. That is just what the IRS does in practice. Losses reduce tax, so the IRS will often disallow losses.
The tangible property regulations changed this by allowing for partial asset dispositions. This allows taxpayers to accelerate depreciation and take it all at once, at the time the property is disposed of. This recovery of tax basis isn’t a Sec. 165 loss. It is a Sec. 168 depreciation deduction. The distinction not only provided something in the law for taxpayers to cite when audited (rather than an abandonment study), it also removed the taint of taking a tax loss.
About the IRS’s Practice Unit Documents
This brings us back to the IRS’s practice unit for partial asset dispositions. The practice unit is one of several. Each practice unit covers a different topic the IRS is concerned about.
The IRS implemented these several years ago. It did so in an effort to improve its dissemination of technical guidance to IRS auditors.
The IRS makes the documents available to the public as the public has the right to them (if the IRS did not make them public, taxpayers could submit a FOIA request to obtain them).
As with the other his practice units, this practice unit covers the basic rules for the topic. It instructs auditors what to look for at a high level.
The IRS’s Partial Asset Disposition Practice Unit
This practice unit also goes into what substantiation the IRS expects for partial asset dispositions. This information is helpful, as it isn’t clear what records are needed to support a partial asset disposition.
The practice unit notes that partial asset dispositions weren’t possible before 2014 and, as such, taxpayers were not required to keep records on potions of buildings. This suggests buildings purchased prior to the 2014 regulations have a less stringent record keeping requirement.
It then notes that the regulations provide a few methods for identifying the asset disposed of. The primary method is using the Producer Price Index Method (PPI). This method looks to the item restored and uses data and a chart to come up with the amount. The practice unit also notes that a pro rata allocation of the unadjusted basis or a study is also sufficient. The practice unit also includes several examples.
While many of the IRS’s practice units aren’t all that helpful, this one is. Taxpayers who are taking partial asset dispositions or who are under audit for partial asset dispositions, should see how their records line up with this guidance. A little tax planning here can go a long way.