In Field Attorney Advice 20154601F the IRS critiqued a taxpayer’s application of the partial disposition rules contained in the proposed tangible property regulations at Proposed Reg. §1.168(i)-8 which are very similar to those contained in the currently applicable final regulations.

In the case in question the taxpayer was attempting to use those regulations to claim a loss on partial dispositions of buildings the taxpayer owned using the late partial disposition election available for a change in method to the revised tangible property regulations.

The taxpayer attempted to compute losses on structural component dispositions (SCD) by undertaking a statistical sampling study to determine the structural components of buildings it had disposed of (as defined in the revised regulations) but was still depreciating. It then used this statistical sample to come up with an overall §481(a) adjustment which it claimed as a loss when filing its Form 3115 to change its method of accounting for dispositions of structural components.

The memorandum takes a look at what the taxpayer did and decides it did not comply with the new rules due to a number of factors.

The IRS first complains that the taxpayer did not limit the matters to MACRS assets only, noting that the regulations only apply to MACRS assets. As the memo notes:

The proposed section 168 regulations only apply to MACRS property. Prop. Treas. Reg. §1.168(i)-8(a). Taxpayer's cost histories recorded assets that Taxpayer depreciated under the pre-MACRS method. Taxpayer cannot recognize a SCD loss when it disposes of pre-MACRS assets. Samples that identify pre-MACRS property as the disposed of asset should not be included when calculating Taxpayer's SCD loss. See Sample No. 104.

The IRS argues the taxpayer in this case had not demonstrated it was not trying to claim a loss for assets for which it had no depreciable basis. The memo notes:

The proposed section 168 regulations only allow a taxpayer to claim a loss on the disposition of an asset or portion of an asset, including leasehold improvements, in which a taxpayer has adjusted depreciable basis at the time of the disposition. Prop. Treas. Reg. § 168(i)-8(c)(3). * * * assumed that Taxpayer disposed of assets in which Taxpayer had adjusted depreciable basis even when the cost histories did not identify adjusted depreciable basis in assets of the type described * * *. * * * also assumed that Taxpayer had adjusted depreciable basis in assets at leased locations even when the cost histories did not show leasehold improvements related to the types of assets described * * *. Taxpayer leases * * * locations and may have disposed of leased assets in which it had no basis when it conducted a capital improvement project described * * * at a leased location. Additionally, Taxpayer may have fully depreciated buildings and structural components at its owned locations. Samples that do not clearly reflect that Taxpayer disposed of an asset or a portion of an asset with remaining adjusted depreciable basis at the time of the disposition should not be included when calculating Taxpayer's SCD loss. See Sample Nos. 77, 135, and 162.

The taxpayer also used the methods in cases where the new asset and the old asset had different recovery periods, a method not all owed under the regulations:

A taxpayer that disposes of a portion of an asset and cannot determine from its records the year that it placed the asset in service can use a FIFO or modified FIFO method of accounting. Prop. Treas. Reg. § 1.168(i)-8(g)(3). * * * relied on a FIFO or modified FIFO method of accounting to identify the asset that Taxpayer partially disposed of for * * * of the sampled records. * * * identified assets in the cost history for the location of the new asset and treated the assets with remaining adjusted depreciable basis and the earliest PIS dates as the disposed of asset or assets. * * * study incorrectly relied on the FIFO method by ignoring single asset accounts with no remaining adjusted basis. Samples that included pre-MACRS assets or that ignored zero-basis assets when determining the disposed of assets should not be included when calculating Taxpayer's SCD loss. See Sample Nos. 104 and 162.

The FIFO method also requires that the new asset and the disposed of asset have the same recovery period. * * * identified a SCD loss even when the new asset and the disposed of asset had different recovery periods. Such samples should not be included when calculating Taxpayer's SCD loss. See Sample No. 10.

The IRS disagreed with the taxpayer’s assertion that even if using the FIFO method it could claim a loss so long as there was any remaining basis at the location. The IRS disagreed, noting:

* * * asserted that so long as Taxpayer had remaining adjusted depreciable basis at a location * * * improved, the oldest assets could be treated as the disposed of assets even if those assets were unrelated to * * * or even if the disposed of assets were fully depreciated. * * * treated assets in the cost histories for Taxpayer's buildings and locations as though they were in multiple asset accounts. * * * identified the cost basis of the new asset * * * and calculated the cost basis of that new asset in * * * dollars. * * * then identified the earliest MACRS assets in the location's cost history and calculated the cost basis of those assets in * * * dollars. * * * then compared the new asset's * * * cost basis to the old assets' * * * cost basis to calculate the adjusted depreciable basis of the old assets (treated as the disposed of assets) and determine Taxpayer's section 481(a)adjustment for a SCD loss. * * * cited Prop. Treas. Reg. § 1.168(i)-8(i), Ex. 8 and Ex. 9 for the proposition that if a taxpayer could not identify the disposed of asset, the taxpayer could use a reasonable method to determine the adjusted depreciable basis of a disposed of asset.

We disagree; Example 8 stands for the proposition that a taxpayer can use a reasonable method to identify the disposed of portion of an asset when the taxpayer cannot determine from its records the PIS year of the asset. Once the disposed of portion of the asset is identified, a taxpayer can use a reasonable method to determine the asset's adjusted depreciable basis.

Example 9 stands for the proposition that a taxpayer can use the specific identification method to identify the disposed of portion of an asset and once identified can use a reasonable method to determine the disposed of portion's adjusted depreciable basis.

* * * failed to identify a disposed of asset or disposed of portion of an asset -- the first step in determining whether a taxpayer had remaining adjusted depreciable basis in the disposed of asset that would allow a taxpayer to recognize a SCD loss.

In Example 8, the taxpayer could identify the assets as: (1) a building (with 40% of the roof remaining as a structural component); and (2) 60% of a roof (in a single asset account). The taxpayer also could identify the disposed of asset at 55% of the roof, but could not determine if that 55% included the remaining 40% of the original roof (a structural component of the building) or the 60% of the previously replaced roof (in a single asset account). The taxpayer could use the FIFO method to claim a loss when it disposes of 55% of the roof by treating the remaining 40% of the building's roof as a partial disposition of the building asset and treating 15% as a partial disposition of the roof asset. Prop. Treas. Reg. § 1.168(i)-8(i), Ex. 8.

While the disposed of 55% of roof is not specifically identified, the disposed of assets (the roof considered part of the building and the roof in the single asset account) are the same item as the new asset (a roof). Taxpayer cannot install a humidifier and claim a loss by writing off the remaining basis of a roof. Taxpayer must be able to identify the asset that it disposes of or partially disposes of in order to establish that there was in fact a disposition and that Taxpayer had adjusted depreciable basis in the disposed of asset at the time of the disposition.

In Example 9, a building owner identifies an elevator as the disposed portion of the asset and knows the PIS year of the building, but cannot identify the cost of the building's elevators, which are structural components. The owner used a reasonable method to identify the unadjusted depreciable basis of the elevator that it replaced in order to claim a loss on the partial disposition of the building when it replaced the elevator. Prop. Treas. Reg. § 1.168(i)-8(i), Ex. 9. The owner had adjusted depreciable basis in the building, had not replaced any other structural components in the same year and, therefore, could claim a loss on the partial disposition of the building. Example 9 does not permit Taxpayer to compare a new asset's cost basis to the cost basis of the oldest assets in its cost histories to arrive at a SCD loss without first identifying the asset that Taxpayer disposed of or partially disposed of.

Thus the IRS found the taxpayer failed to establish an identified asset on which a loss could be claimed.