Small and medium-size entrepreneurial businesses are sometimes blessed with a good idea but many similar or identical capital assets and not much time or accounting prowess to keep track of them all individually. Larger businesses may seek more efficient tax treatment for standard capital assets, such as laptop computers issued to a large number of employees.
In either case, the answer may be general asset accounts (GAAs). GAAs group together assets that share common characteristics and are depreciated as if they collectively represent one asset. A possible disadvantage is their restrictions on dispositions that qualify for immediate recovery of remaining basis. Also, the Small Business Jobs and Credit Act (PL111-240) increased the IRC § 179 expensing limits to $500,000, with the phaseout threshold raised to $2 million, and bonus depreciation extended, both for 2010 and 2011 tax years. Those options may now be more attractive than previously for businesses’ capital equipment acquisitions.
In many instances, the difference between GAA and regular treatment is one of timing of tax liability rather than amount. Generally, a GAA will result in higher taxable income when assets are sold or disposed of early in their class life. Therefore, GAAs are most suitable when the taxpayer plans to keep the assets in service for their full class life or to make only qualified dispositions, as explained below.
Acquisitions. Under IRC § 168(i)(4) and Treas. Reg. § 1.168(i)-1(c)(2)(i), each asset in a GAA must have the same:
(a) Asset class (see special rule below);
(b) Depreciation method;
(c) Applicable recovery period;
(d) Applicable convention; and
(e) Tax year in which it is placed into service.
Under Treas. Reg. § 1.168(i)-1(c)(2)(ii), if an asset does not have a class but possesses the same characteristics as in (b) through (e) above, it may be grouped into that GAA.
Any asset that is subject to section 168(a) (the general rule for the accelerated cost recovery system) or section 168(g) (alternative depreciation system for certain property) may be accounted for in one or more general asset accounts. Only the amount of the asset’s unadjusted depreciable basis may be placed inside a GAA. For instance, if a business takes a section 179 expensing election on an asset that would otherwise qualify for GAA inclusion, then the amount after the section 179 deduction is placed in the GAA (Treas. Reg. § 1.168(i)-1(c)(1)(i)).
Regular dispositions. Except for “qualifying dispositions” described below, when an individual asset within a GAA is disposed of, the basis of that asset is deemed to be zero. Therefore, any proceeds received from the sale are ordinary gain, and no loss is recognized. The unadjusted depreciable basis—typically the original cost—and the accumulated depreciation of the GAA are unaffected by the disposition. In other words, depreciation continues as if the GAA had the same original assets as when it began. If all the remaining assets in the GAA are disposed of in a single year, the GAA may be terminated in that year and any adjusted depreciable basis recovered.
Qualifying dispositions. In the case of a qualifying disposition (Treas. Reg. § 1.168(i)-1(e)(3)(iii)), the taxpayer may treat the sold assets as segregated from the GAA, calculating depreciation for the year of disposition and recognizing gain or loss as if the segregated assets had been separate assets all along—essentially like any other disposition of depreciable property. The taxpayer exercises this option by reporting the gain, loss or other deduction on the taxpayer’s timely filed federal income tax return (including extensions) for the taxable year in which the disposition occurs. A qualifying disposition is one resulting from a casualty or theft, charitable contribution, termination of the business or that unit of the business, or certain dispositions subject to nonrecognition provisions other than like-kind exchanges or involuntary conversions under section 1031 or 1033. A like-kind exchange of an asset in the GAA under section 1031 or 1033 terminates GAA treatment as of the first day of the year of disposition (Treas. Reg. § 1.168(i)-1(e)(3)(v)(B)).
One further possible disadvantage—or at least a complicating factor—of GAAs is the requirement to allocate any foreign-source income upon the disposition of an asset within a GAA. The allocation and apportionment to foreign-source income is based upon the amount of depreciation allowed for the GAA either at the end of the taxable year of the disposition; depreciation allowed if the GAA is terminated due to a qualifying disposition or last-asset disposition; or depreciation allowed for the year of disposition only if there is a qualifying disposition (Treas. Reg. § 1.168(i)-1(f)).
Procedures for Adopting GAAs
Treas. Reg. § 1.168(i)-1(i) requires only that the taxpayer consistently use any reasonable method for determining the unadjusted depreciable basis of the GAA and be able to identify any conversion to personal use or a qualified disposition. The election, made on a timely filed (including extensions) income tax return for the year in which the assets are placed into the GAA, is irrevocable for all years in which the GAA is in effect. The election is made on Form 4562, Depreciation and Amortization.
Example: Disposition of Assets
A limited partnership with various types of entities comprising the partners has purchased 500 machines at $125 each and placed them into service throughout 2010. They are five-year assets and not subject to the mid-quarter convention, and no section 179 expensing is taken. For purposes of this example, bonus depreciation is ignored; however, it would work just like a section 179 election, in that if taken, it would reduce the depreciable basis of the GAA.
The following assumptions exist:
- Year 1 – no dispositions
- Year 2 – disposition of 75 machines for $50 each
- Year 3 – no dispositions
- Year 4 – disposition of the remaining 425 machines for $40 each and election made to terminate the GAA
A Microsoft Excel interactive spreadsheet provides a summary, detail and comparison of the Year 2 dispositions, as well as a possible format for attachment to the income tax return and detail tracking. (Click here to download the Excel spreadsheet.) In the second tab, labeled “Detail,” users may substitute their own values for number of assets, cost or other basis, sales price and applicable tax rate. You can also download a Microsoft PowerPoint presentation available for modification and presentation to your clients. (Click here to download the presentation.)
As the example shows, over the entire comparison horizon, there is no net taxable income difference between GAA and regular treatment, but there is a difference in the timing of tax liability. With a sale of assets in Year 2, the GAA treatment entails higher taxable income at that point than with regular treatment. Therefore, GAAs are most suitable when the taxpayer plans to keep the assets in service for their full class life or to make only qualified dispositions. Note, too, that there could be a change to tax liability based upon the type of entity involved. Also, if any of the assets were sold for more than their original cost, instead of recognizing depreciation recapture and section 1231 gain, all of the gain would be recognized as ordinary income. In this example, the likelihood of that occurring is remote, but it would be a consideration if the possibility exists for substantial gain.
When a substantial amount of similar assets are involved, the business adviser should consider whether the staff time savings in tracking each asset on the balance sheet outweighs the potential tax liability from ordinary income treatment on the sale of assets. Especially if the sale of assets is a remote occurrence, then GAAs might be just what the doctor ordered.
By Gregory L. Buhrow, CPA, MBA, (email@example.com) president of Gregory L. Buhrow, CPA, PC, Dallas.
To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at firstname.lastname@example.org or 919-402-4434.
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