Pub. 2 2014 Issue 4

26 San Diego Dealer A s the auto industry continues to recover, dealerships are spending a lot of money updating the look and feel of their facil- ities: color scheme changes, marketing updates, even complete rebrandings of sales and service facilities. This trend has raised questions about proper accounting treatments for the incurred costs. Last year the IRS released its final tangible property regulations. Al- though generally effective for tax years beginning on or after January 1, 2014, taxpayers may elect to implement the regulations for tax years beginning on or after January 1, 2012. What does this mean for you if you’ve updated, expanded, or refreshed your stores? The potential to reduce your tax burden. But the first thing to consider is whether your costs represent a repair expense or a capital improvement. Although a building and its systems are a single unit of property, the regulations require an analysis of the work performed on the build- ing’s structure (walls, floors, partitions, ceilings, windows, doors, and other structural components) or systems (HVAC, plumbing, electrical, escalators, elevators, fire protection and alarm, security, gas distribu- tion, and other components identified in the guidance). An improvement occurs when the costs paid result in the unit of prop- erty’s betterment, adaptation to a new or different use, or restoration (BAR). Betterments include costs that ameliorate a material condition or defect that result in material addition to the unit of property, including the addition of a major component, or that result in a material increase in its capacity, productivity, efficiency, strength, quality, or output. For example: • After years or wear and tear, a dealership refreshes its showroom lighting and floor electrical outlets, also repairing floors, ceiling tiles, and paint to coordinate with a brand refresh. These costs can be deducted, since the work keeps the dealership in its normal operating condition and makes no material additions to its capacity or efficiency. • A one-story dealership has a showroom with high ceilings. To create more office space, it adds a stairway and mezzanine, which are now part of the building structure. These costs would likely treated as betterments because they represent a material addition to and an increase in the capacity of the building structure. Adaptations to a new or different use must also be capitalized. This occurs when a property’s new use isn’t consistent with the taxpayer’s original intended use at the time the property was placed in service. Let’s say a dealership purchases a warehouse to store parts and tires for the cars it sells. After two years it decides to decrease that invento- ry and turn the warehouse into a showroom, vehicle service area, and offices. Since this isn’t consistent with the original plans for the facility, reconfiguring the warehouse to a dealership would likely be consid- ered an adaptation, and expenses must be capitalized. The third part of the BAR test is the restoration test, which includes amounts paid to replace a major component or substantial structural part of a building. Let’s say a dealership decides to replace three of its 10 HVAC units. Because HVAC systems are one of the nine building systems in the regulations, the cost to replace the units is measured against the overall HVAC system. Under the regulations this wouldn’t be a restoration because the 10 HVAC units together constitute a major component of the HVAC system, and the replacement of three units isn’t a significant portion of that major component. However, if the chiller unit—which is considered a major component of the HVAC system—were to be replaced, that cost would be capitalized as a restoration. The final regulations also include an expanded routine maintenance safe harbor and new partial asset disposition guidance. These rules can be complex, so it’s worth discussing with your accounting firm how they may apply to your dealership. In addition, a cost segregation study might also be a good idea to help you quantify your costs and separate your building components. The bottom line? Dealerships must be aware of the final tangible prop- erty regulations and understand how to best leverage their account- ing options under the new guidance. Sid Tobiason has more than 33 years of tax experience, with a focus on federal income and estate taxation of dealerships. You can reach him at (858) 627-1448 or sid.tobiason@mossadams.com. Amy Stillwell works with dealership owners on federal income and estate planning. You can reach her at (858) 627-1410 or amy.stillwell@mossad- ams.com . Expense or Capitalize? New IRS Rules and How They Apply to Your Dealership By Sid Tobiason, Partner, and Amy Stillwell, Manager, Moss Adams LLP