Examining the Partial Asset Disposition Deduction

This article provides an overview of the process for examining the taxes of building owners who have elected a partial disposition of a building or its structural components under IRC 168 disposition regulations. The process involves five key steps:

Step 1: Determine If Partial Disposition Occurred

The examiner must first verify that a partial disposition took place. Considerations include:

1. Reviewing the taxpayer's record-keeping practices and verifying they have maintained proper records for depreciable assets.
2. Knowing what qualifies as a disposition under the regulations - these include sales, exchanges, retirements, physical abandonments, or destructions of an asset.
3. Confirming the taxpayer had a depreciable interest in the disposed portion.
4. Verifying the disposed asset was MACRS property (placed in service after 1986) and not fully depreciated.
5. Checking if the disposition was a required partial disposition (e.g. casualty loss, sale of portion of asset).

The taxpayer has the burden of proof to substantiate that a partial disposition occurred. The examiners cannot assume a disposition happened because an improvement was made.

Step 2: Identify the Disposed Portion of the Building

The taxpayer must be able to specifically identify what portion of the building or structural component was disposed of. This cannot be based solely on depreciation schedules or fixed asset listings. Key points:

• The disposed portion must be of the same type and location as any replacement asset.
• Work orders, purchase orders, construction drawings, etc. should be reviewed to verify the specific portion disposed of.
• For leased buildings, verify the taxpayer had a depreciable interest in the disposed of portion.

Step 3: Identify the Asset That is Partially Disposed of and Its Placed-in-Service Date

The taxpayer must identify which specific asset contained the disposed portion and when that asset was originally placed in service. This starts with the taxpayer's records, but simplified methods are allowed if records are insufficient:

• Specific identification method should be used if possible based on records.
• If impracticable to determine from records, taxpayer can use:
  • First-in, first-out (FIFO) method
  • Modified FIFO method
  • Mortality dispersion table (for mass assets only)

The disposed portion must be of the same type, location, and recovery period as any replacement asset. Pre-MACRS assets and fully depreciated (zero basis) assets cannot be ignored when applying simplified methods.

Step 4: Determine the Adjusted Basis of the Disposed Portion

To calculate the gain/loss on disposition, the adjusted basis of the disposed portion must be determined:

• Start with the unadjusted basis (typically cost) of the entire asset.
• If impracticable to determine from records, reasonable methods can be used to calculate the unadjusted basis of the disposed portion:
• Discounting replacement cost using price index
  • Pro rata allocation based on replacement costs
  • Cost segregation study
  • Reduce unadjusted basis by depreciation allowed/allowable to get adjusted basis.

Step 5: Account for the Disposed Portion

The final step is to properly account for the partial disposition:

• Move the unadjusted basis of the disposed portion to a separate single-asset.
• Reduce the unadjusted basis of the original asset by the disposed portion's basis.
• Adjust accumulated depreciation on the remaining portion of the original asset.
• Calculate allowable depreciation on disposed portion up to disposition date.
• Determine the final adjusted basis of the disposed portion at the time of disposition.

Throughout the process, the examiner should verify the taxpayer is following proper procedures and maintaining adequate records. If issues are found, the examiner may need to disallow the partial disposition, adjust gain/loss recognized, and adjust the basis of assets. Involuntary accounting method changes may be required.

Additional Key Points

• The partial disposition election is available for tax years beginning or after January 1, 2014.
  Partial dispositions are required in certain cases like casualty losses or sales of a portion of an asset.
• Simplified methods are only available for identifying assets and placed-in-service dates, not for determining if a disposition occurred or identifying the specific portion disposed.
• The taxpayer must use consistent methods when determining the unadjusted basis of disposed portions of the same asset.
• Buildings and structural components are typically held in single-asset accounts, not multiple-asset.
• The remaining portion of a partially disposed asset continues to be depreciated using the original method, recovery period, and convention.

Examination Considerations

When examining partial dispositions, examiners should:

• Review the taxpayer's books, records, and methodology thoroughly.
• Verify dispositions are properly substantiated and not just assumed based on improvements.
• Ensure disposed portions match replacement assets in type, location, and recovery period.
• Check that pre-MACRS and fully depreciated assets are properly handled.
• Verify reasonable methods are used to determine basis when records are insufficient.
• Confirm proper accounting for the disposition in the taxpayer's books and records.
• Make adjustments and consider involuntary method changes if issues are found.

The examination process requires careful analysis of the taxpayer's records and calculations at each step. Examiners must verify the taxpayer has met their burden of proof in substantiating the partial disposition before allowing the resulting loss deduction. Proper application of the regulations and simplified methods is critical to ensure accurate reporting of partial dispositions.