The Tangible Property "Repair" Regulations: Unit of PropertyJune 08, 2012
Crystal Germanese, CPA
In order to understand whether or not there has been an improvement to tangible property required to be capitalized under the temporary regulations, it is essential to understand the unit of property for that purpose. For example, if you replace the roof on your building, if the unit of property is the roof, then replacing it would clearly be a material improvement. If the unit of property is the building, then it might not be as clear to say that the building was improved by replacing the roof. Therefore, the temporary regulations define the unit of property rules for the purposes of section 263(a).
In general, the unit of property determination is based upon the functional interdependence standard. However, special rules are provided for buildings, plant property, network assets, leased propertyand improvements to property. Additional rules are provided if a taxpayer has assigned different MACRS classes or depreciation methods to components of property or subsequently changes the class or depreciation method of a component or other item of property. Property that is aggregated or subject to a general asset account election or accounted for in a multiple asset account (e.g., pooled) may not be treated as a single unit of property.
The temporary regulations include new unit of property determination rules for buildings. In general, each building and its structural components are a single unit of property. However, for the purposes of determining whether an improvement was made, the building structure and each building system needs to be considered separately.
The building structure consists of the building and its structural components not designated as separate building systems. The building’s systems that the temporary regulations have broken out and defined are:
- Heating, ventilation and air conditioning (“HVAC”) systems (including motors, compressors, boilers, furnace, chillers, pipes, ducts, radiators);
- Plumbing systems (including pipes, drains, valves, sinks, bathtubs, toilets, water and sanitary sewer collection equipment, and site utility equipment used to distribute water and waste to and from the property line and between buildings and other permanent structures);
- Electrical systems (including wiring, outlets, junction boxes, lighting fixtures and associated connectors, and site utility equipment used to distribute electricity from property line to and between buildings and other permanent structures);
- All escalators;
- All elevators;
- Fire-protection and alarm systems (including sensing devices, computer controls, sprinkler heads, sprinkler mains, associated piping or plumbing, pumps, visual and audible alarms, alarm control panels, heat and smoke detection devices, fire escapes, fire doors, emergency exit lighting and signage, and firefightingequipment, such as extinguishers, hoses);
- Security systems for the protection of the building and its occupants (including window and door locks, security cameras, recorders, monitors, motion detectors, security lighting, alarm systems, entry and access systems, related junction boxes, associated wiring and conduit); and
- Gas distribution system (including associated pipes and equipment used to distribute gas to and from property line and between buildings or permanent structures).
Therefore, when applying the improvement rules to a building, an amount paid is considered an improvement if it is made to either the building structure or one of the building systems. For example, if a taxpayer owns an office building that contains an HVAC system which incorporates ten roof-mounted units and pays for an upgrade to its HVAC system including all roof top units, that would result in an improvement because it is an improvement to the HVAC system. On the other hand, if the only work done was to replace two of the roof top units and no other work was performed, the two roof top units by themselves do not comprise a large portion of the physical structure of the HVAC system or perform a discrete and critical function in the operation of the system, and therefore would not be considered an improvement.
The temporary regulations also provide special rules for determining the unit of property when the taxpayer is the owner of a condominium, a cooperative or a lessee. In general, the unit of property of a condominium or cooperative is the individual unit owned by the taxpayer or the portion of the building in which the taxpayer has possessory rights. In the case of a taxpayer that is a lessee of all or a portion of a building, the unit of property is each building and its structural components or the portion of each building subject to the lease and the structural components associated with the leased portion.
Defining the unit of property for property other than buildings is generally based on a functionally interdependent test. Components of property are functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayerand are, therefore, considered one unit of property. For example, if a taxpayer owns locomotives used in its railroad business and each locomotive consists of various components, such as an engine, generators, batteries and trucks which are all treated as being within the same class of property, the locomotive would be a single unit of property because it consists entirely of components that are functionally interdependent.
Special rules are provided for plant property and network assets.Plant property is defined as functionally interdependent machinery or equipment, other than network assets, used to perform an industrial process, such as manufacturing, generation, warehousing, distribution, automated materials handling in service industries or other similar activities. In the case of plant property, the unit of property determined under the general rule is further divided into smaller units comprised of each component (or group of components) that performs a discrete and major function or operation within the functionally interdependent machinery or equipment.
Network assetsare defined as railroad track, oil and gas pipelines, water and sewage pipelines, power transmission and distribution lines, and telephone and cable lines that are owned or leased by taxpayers in each of those respective industries. The term includes, for example, trunk and feeder lines, pole lines and buried conduit. In the case of network assets, the unit of property is determined by the taxpayer's particular facts and circumstances, except as otherwise provided in published guidance in the Federal Register or in the Internal Revenue Bulletin. For these purposes, the functional interdependence standard provided is not determinative.
A unit of property also must be treated as a separate unit of property if at the time it is placed into service the taxpayer has treated the component as being within a different class of property than the class of the unit of property of which the component is a part. For example, if a taxpayer owns a fleet of truck tractors and trailers and places the tractors and tires into service as separate assets, using a three-year life for the tractor and a 5-year life for the tires, the tractor and the tires which are functionally interdependent would be considered separate units of property because they are treated as different classes of property. The same holds true if a taxpayer properly changes the original determination after the unit of property is placed into service, for example as the result of a real estate cost segregation study.
We have compiled a series of additional articles to help taxpayers understand the new rules and understand how they will be implemented.
- Amounts Paid to Acquire or Produce Tangible Property
- Improvement to Tangible Property
- Asset Accounting and Dispositions
- Change In Accounting Method to Comply With the Tangible Property Regulations